Archive for the ‘legal separation’ 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 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.