Archive for the ‘abandoned spouse’ Tag

Divorce Taxation – Part III

Originally published in the Pacific Grove Hometown Bulletin

July 4, 2012

Since it is July 4th, and we are discussing divorce, I suppose it would be appropriate to say, “Happy Independence Day!”

Tax Carryforwards

When going through a divorce it is important to realize you may have valuable “tax assets” that need to be divided according to tax law or negotiated between spouses.  Capital loss carryforwards (such as those generated by stock sales) are supposed to be allocated based on whose assets from the past created the losses.   Net operating loss carryforwards (such as those generated by a large business loss) are supposed to be determined by recalculating what the losses would have been if you had been filing separate.  Minimum tax, general business credit, and investment interest expense carryforwards can be negotiated.

Suspended passive activity losses (such as those generated by rental properties) go with the individual receiving the property, however, there are some pitfalls to avoid that could require the passive activity losses to be added to basis, rather than becoming immediately available to the spouse receiving the property.  If you happen to have bought a house with the $8,000 homebuyer credit that has to be repaid, the person who takes the home becomes solely responsible for repayment.

In practice, I have not seen the IRS come down heavily on how carryforwards are divided, but it is important to know what you are entitled to, so you do not miss out on something that could save you money down the road.

Children

Children present a number of planning issues in a divorce.  Tax benefits related to children include the child’s exemption, child tax credits, dependent care credits, exclusion of income related to dependent care benefits, earned income credits, education credits, and head of household filing status.  The custodial parent (defined for tax purposes as the parent who lived with the child most during the year) is generally the one eligible for these benefits, although the custodial parent may release two of those (the exemption and child tax credits) to the noncustodial parent by filing Form 8332, and keep the remaining benefits. As discussed in a previous issue in this series, it is also possible for both spouses to claim head of household if the abandoned spouse rules are met.  If both parents meet certain qualifying child rules, they can also each claim medical and health insurance expense deductions they pay for the child and can distribute money from HSAs, MSAs, etc. for the child’s benefit.  When multiple children are involved, planning can be done to preserve the head of household status for both spouses.

Child support payments are not taxable income to the recipient parent, nor are they deductible by the parent paying the child support.  Alimony on the other hand is income to the recipient, and deductible by the paying parent.  Be sure your divorce decree is clear and specific on the payment of alimony and child support.  Alimony is a tricky area and you must be very careful about how it is paid.

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.