Tax Tips for Divorcing Spouses

pwalzer
Tax Day is coming up fast.  These ten tips might help you avoid tax nightmares and save you money:
    1.  Alimony payments are tax deductible if they are paid pursuant to a court order or agreement. (31a of your tax return) Make sure your order does not violate the recapture rules.  See IRC section 71 for the rules.
    2.  Alimony payments are taxable if received pursuant to a court order or agreement.  If you have not paid quarterly estimated payments, you could have a large tax bill.  Make sure you plan for next year’s taxes by making estimated quarterly payments.
    3.  Attorney’s fees incurred for the purpose of getting you alimony or income from your spouse’s retirement plan (think QDRO’s) are tax deductible if they are more than 2% of your adjusted gross income, subject to alternative minimum tax caps.  If your attorney provides you with tax advice, that may also be deductible, too.  Ask your attorney to give you a breakdown of what portion(s) of your bill may be tax deductible.
    4.  Filing status is important.  A divorced husband and wife may each be able to file as Head of Household if they have two or more children and they are sharing custody.  Also, make sure that the parent who can benefit from the dependency exemptions gets them.  Use IRS Form 8322 to transfer these exemptions.
    5.  Use the tax laws wisely to produce more net spendable income for both the spouse paying alimony and the spouse receiving it.  If the receiving spouse pays the mortgage and property taxes they can offset some of the tax on the alimony they receive.
    6.  Often spouses going through a divorce are cash strapped, and the only available source of funds is in a 401K.  If you are dividing a retirement plan, you can include a provision for cash distribution in the QDRO.  The cash distribution is penalty free, but taxable to the receiving spouse.
    7.  When dividing property, take into account the basis (cost + improvements) of the property, which will affect the taxes you would pay on the sale of that property.  If you have two properties of equal value, and one has a lower basis, that property is worth less to you than the one with the higher basis.
    8.  You may be able to withdraw funds penalty free from an IRA if you take them out in substantial equal periodic payments (SEPPs) for five years or until you are 59.5 years of age.  The rules are complex, so obtain tax advice before you take this election.
    9.  If you are getting married, wait until after marriage to transfer assets to your spouse.  No gain or loss is recognized in transfers between spouses (or former spouses incident to a divorce).
    10.  Filing jointly with a spouse can result in lower taxes than filing separately, but filing jointly will make you jointly liable for the taxes, penalties and interest.  If you already filed jointly and the IRS is pursuing you, you may be entitled to Innocent Spouse Relief (IRS Form 8857).
For more information on Family Law matters, or for a referral to a tax specialist, email Peter at pmw@walzermelcher.com