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Divorce & Taxes: Keeping Uncle Sam Out of the Family

The financial and tax issues couples face during and after divorce are often complex. Financial counseling is often necessary.

It is common for one spouse to have more knowledge in these areas than the other. Often divorce attorneys, with the assistance of financial and accounting professionals, offer advice to develop an effective plan for “unwinding” the couple’s business dealings. The goal is to reflect the new financial realities both spouses face and to fairly spread taxes owed, tax credits, and deductions.

Tax and economic issues must be reviewed when determining who gets the house, the business or the investment accounts. Additional issues arise in the areas of maintenance and child support payments. Here are some things divorcing couples should consider:

What do we own and what is it worth?

  • Compiling a list of assets is one of the first steps of the divorce. The value of such assets is more difficult to determine. Make sure to consider:
    • Revaluing investments as of the trial date and compare to the date of separation. You may need to revalue the investments several times during the divorce proceedings.
    • Looking at the built–in gains on investments – capital gains taxes can erode up to 25% of the market value.
    • Valuing the business on both a historical basis and based on projected future earnings.
    • Establishing the cost (tax) basis in the family home.

I wasn’t involved in the financial affairs during our marriage. What kind of problems may arise and what protection is available to me?

  • When filing income tax returns using “married filing jointly” status, both spouses are responsible (individually and jointly) for any tax due as well as any additional taxes, penalties or interest due on the return. Divorce does not relieve a spouse from owing additional tax on a joint return that was filed prior to the divorce. There is some protection, however. The Innocent Spouse Rule provides relief from responsibility for a former spouse’s tax bill when the following conditions are met:
    • A joint return was filed;
    • There is a substantial understatement (defined as at least $500) of tax due to income deductions, credits or basis of the former spouse; and
    • The spouse seeking relief can establish that when the return was signed he or she did not know and had no reason to know that such an understatement existed.

How are the children and child support treated for income tax purposes?

  • The divorce decree will include information relating to who gets to claim the children as dependents. This is important because that spouse then can take a tax exemption. Often the exemption will be shared and you and your former spouse will alternate years in which you take the tax exemption.
  • Child support is not subject to income tax. The income received and the amounts paid have no tax effect. However, child support is a contentious issue. By the time all the other issues surrounding custody, visitation, and other child related matters are addressed, the financial issues can be difficult. It is important to review financial records and prepare a budget for such support. Being well prepared to address these issues can assist in preventing protracted disputes and additional legal and emotional costs in the future.
  • Other child related tax issues to consider are:
    • How much has the child(ren) earned (including interest, dividends and investment activity) during the year?
    • Does either spouse qualify for the child tax credit?
    • Who pays for childcare and is that person eligible for dependent care tax credits?

Asset division, financial support, and income tax matters can create unease in the divorce process and after. Consult with your divorce attorney about these matters, and bring in financial and accounting professionals if needed. Working diligently and openly in these areas can help you firmly establish your “new” family while keeping your former spouse and Uncle Sam out of it!

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