Divorce: a taxing issue
If you're about to sever the knot, keep the tax implications in mind
NEW YORK (CNNfn) - You've made up your minds. The marriage is over.
It's the only thing you've agreed upon in the last five years.
But when it comes to the tax implications of divorce, experts say it's best to keep the lines of communication open - and in some cases, to stick it out for a little longer, if you can take it.
"Divorcing couples have to consider one tax question after another as they go through the separation process - questions ranging from alimony and child support, to who gets the house and who claims deductions and credits," said Mark Luscombe, a certified public accountant and principal tax analyst for CCH Inc. "Often, they will have to bargain and strike agreements if they want to avoid paying more than they have to in taxes."
Severing the knot
Some 2.5 million people in the United States file for divorce each year.
Diane Neumann, head of Divorce Mediation Services in Newton, Mass., said many are so eager to sign the papers, they forget to address the issues that effect them most, including taxes.
For example, if your final divorce decree has not come through by Dec. 31, you have to decide if it's more beneficial to file jointly or separately.
That's especially true if there's a huge gap in your incomes. If, for instance, the husband makes $150,000 and the wife makes $20,000, Neumann said that couple could save up to $20,000 in taxes if they file jointly, money that can be used to help pay for the divorce expenses.
If you determine that filing jointly one last time will save you a substantial amount of money, you may even consider postponing the divorce until the following calendar year to benefit from lower tax brackets, a larger standard deduction and tax credits.
The Internal Revenue Service requires that your tax return reflect your marriage status on the last day of the filing year.
"If one spouse earns a lot more than the other they are going to save an enormous amount of money if they can file jointly one more year," she said. "In a divorce settlement, there's just not enough money to go around."
Do you have kids?
If children are entangled in the divorce, carefully consider which spouse will benefit from the child tax credits you might have gained under the Taxpayer Relief Act of 1997. Those include the Hope credit and Lifetime Learning credit, both of which offer tax relief for tuition costs.
In the case of divorce, these credits are only available to the parent who claims the child as a dependent regardless of who pays the college expenses.
"I had a case where the husband was fighting to claim the credit, but he made way too much money," Neumann said. "They would have lost that credit if the wife didn't take it. She agreed to split it with him."
As a footnote, Susan Jacksack, a tax analyst for CCH and author of a new tax guide, said you should be careful how you characterize your spousal support payments.
Alimony is subject to fewer taxes, but child support can be wiped out if the person making the payments files for bankruptcy.
"If there is any question about the solvency of the person paying, they may want to forget the tax benefit and characterize (those payments) as child support," Jacksack said.
Lastly, consider the tax ramifications of who ends up with the house, and the capital gains tax you be subjected to if you get the stock investments.
Tips you may not know
Judy Colbert, author of Divorce Common Sense Handbook, has a few other words of wisdom for the disenchanted spouse.
If you're the first to move out of the house, don't automatically sign over the exclusive occupancy rights to your spouse. You may lose the tax benefit of any future sale by doing so.
In the case of a joint return, Colbert said you should also pre-determine who will pay any taxes that might be owed, and how a refund will be divided.
And, if your divorce is especially sticky and you are the one collecting alimony, be sure to indicate in the contract that your monthly payments will be based on a percentage of your ex-spouse's income - not salary.
A spiteful ex- could otherwise use the term "salary" as a loophole, asking his boss to pay him $1 a year as salary and the rest in a compensation package that includes stock options and annuities. (We hope it doesn't get that bad.)
Experts suggest you talk to a tax attorney or accountant to find out how to keep taxes to a minimum, which can help to make a painful situation easier.
If you're willing to be patient, Neumann said you can save yourself a bundle - and a lot of disputes down the road.
"I tell people that divorce is a lot about how much money you want to spend - and that includes lawyers and the IRS," she said.
--by staff writer Shelly K. Schwartz