Archive for June, 2012|Monthly archive page

Divorce Taxation – Part II

Originally published in the Pacific Grove Hometown Bulletin

June 20, 2012

Community Property/Income and Deductions

A complicating factor with divorces is that state law governs a good bit of how taxation will work, and each state has different laws. California is one of nine community property states.  It is has similarities to other community property state tax laws, but differences as well.  In California, community property laws say that income and deductions derived or expended while married are generally split 50/50 during the community period.  The income and deductions generated after the community period ends belong to each taxpayer.  The community period for California purposes ends when the taxpayers separate with no intent to get back together.  This does not require a final decree of divorce or separate maintenance, but is based on facts and circumstances.

Many divorcing couples often take the approach, “You report your W-2 on your returns and I will report mine on my returns,” but that is technically not correct since in most cases they should each be reporting half of each other’s W-2 during the community period.  Spouses are required to provide the necessary information for the other spouse to file a complete and accurate return.  This situation can lead to an advantage or an abuse depending on the familiarity of each spouse with the tax laws.

Although the laws do get complex, generally speaking, community property is anything acquired during the community period, or any separate funds brought into the marriage that are tainted by intermingling the funds with community funds. If the taxpayer maintained any separate property during the marriage, then the income and deductions for separate property would go to the spouse who owned the property.  An example of this would be: Spouse A brings a rental property and a large bank account to the marriage and maintains it in his or her own name.  Spouse A uses the bank account exclusively for the rental property and pays all rental property expenses and deposits all the rental property income into the bank account.  Since there is no intermingling with any assets created after the marriage began, the property would maintain its character as separate property and the income and deductions would fall 100% to spouse A in the year of divorce.

Splitting Tax Withholdings and Estimates

Taxes withheld (such as with a W-2) during the community period are generally split 50/50.  Estimated tax payments made are credited under the taxpayer whose social security number is submitted with the payment.  Individuals going through a divorce should be alert to this as they may not realize the other spouse has made payments in their own name from community property funds.  For California, estimated payments with both social security numbers submitted are applied to the tax return of the first taxpayer to file.  However, taxpayers are supposed to submit a notarized statement signed by both individuals prior to either filing, specifying how the taxes withheld and joint estimates should be applied.  Note, a court order in the divorce proceedings will control and overrule any of these laws, including a retroactive application of joint estimated payments to the spouse the court order specifies.

To be continued next issue…

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

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Divorce Taxation – Part I

Originally published in the Pacific Grove Hometown Bulletin

June 6, 2012

Once in a while, I work with clients that are going through a divorce.  And once in a while in those once in a whiles, I work with clients who are both happily going through the divorce process, and seem to get along better than most married couples I know!  Most of the time, however, it seems to be a challenging and confusing time with a lot of mixed feelings on both sides.  Another aspect of divorce that can be challenging and confusing is the taxation in the years surrounding the divorce.

One of the most common themes I see with individuals going through divorce is that many tax issues are not even considered in the process.  People know it is a good idea to hire an attorney, but they forget to consult a competent tax professional about how it will play out, or what they may want to have their attorney negotiate on their behalf.  For many people they think the only tax consideration is who gets to claim the child, if one is involved.  In reality, there are several big issues to consider, and the tax law can sting those who are not aware.

In the next few issues I will go over some of the ground rules and areas of interest pertaining to taxation during a divorce including filing status options, community property laws, splitting income and deductions, crediting tax withholdings and estimated payments, allocating carryforwards, effects of children, transferring assets, and court orders.  It is also important to note that state law heavily governs divorce taxation.  I will be speaking from the perspective of California residents throughout the articles.

Filing Status

A basic question when going through a divorce is “What filing status should I use?”  The answer is that it comes down to your status on the last day of the year.  Taxpayers are considered unmarried for tax purposes if the final decree of divorce or a decree of separate maintenance is obtained by the end of the year.  If either of those two triggering events occurs, they would file Single or Head of Household returns as applicable.  Otherwise, they are still considered married and would file joint returns or Married Filing Separate returns.

One interesting exception, however, is that one or both individuals can claim Head of Household status while still married if they meet the Head of Household rules, and the spouses did not live together during the second half of the year.  These rules are sometimes referred to as the “abandoned spouse rules.” Many tax preparers are unaware of these rules, but they can be quite advantageous since divorcing individuals often do not want to file jointly, and Head of Household status is typically much better than Married Filing Separate.

To be continued next week…

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.