Brotman Law Presents
The Ultimate Guide to Innocent Spouse Relief, Divorce, and Taxes
Divorce situations are frustrating enough until you throw a tax challenge into the mix. Luckily, our firm's experience in helping clients navigate through taxes when they are getting divorced helped us write the book on how to handle many common problems.
An Innocent Spouse Relief Attorney Discusses Taxes and Divorce
Describing the divorce process, a client once said that splitting assets in a divorce was like separating delicate strands of a spider’s web.Coming to terms with a divorce may at times feel like an impossible mess to unravel; let alone to later find yourself in further entanglement with the IRS.
With the right guidance from a divorce and innocent spouse relief attorney, however, you can untangle the web of divorce dilemmas for good; at least from a tax perspective.
Tax issues are in actuality like dividing a piece of property in many respects; however, in most cases, it is not something that is wanted by either spouse. Like any financial obligation, taxes must be dealt with responsibly in the division process and this is especially true because of the might of the creditor in this situation.
Additionally, depending on the complexity of the situation, division of tax liability or allocating payment of tax liability to one spouse, can get pretty complicated and may involve multiple accounts and attorneys to resolve the issue.
The frustrating thing about divorce and taxes for many clients is that the IRS and the State of California do not respect any agreements that are reached between spouses in a divorce setting. Collections and examination procedures often get very complicated because situations where the spouses are not cooperating can make the process exponentially more difficult.
With the right guidance from a divorce and innocent spouse relief attorney, however, you can untangle the web of divorce dilemmas for good; at least from a tax perspective.
Complicating things more is that many family lawyers and even family court judges do not understand the full ramifications of the divorce and the separation of spouses on your taxes.
Even though transfers of property pursuant to a divorce enjoy tax free treatment, income earned on the sale of assets is still taxed and the tax benefits of a divorce situation is often not completely thought through by family counsel because it is not their core competency.
Our firm often encourages tax planning around major life transition events (ex. retirement, death/generational transfers of wealth, etc…), but divorce is probably the most major area where people fail to engage in substantive planning.
The situation becomes exponentially more difficult in high conflict divorce settings or where the situation involves an innocent spouse relief. Trying to move in the same direction with opposing spouses on a complicated and potentially damaging issue to one or both of them is like trying to sell a popsicle to a person with white gloves on.
Often the biggest challenge in divorce cases for our divorce and innocent spouse relief attorneys is sometimes not the IRS or the State of California. It can be the people, particularly if one spouse is being completely and totally unreasonable.
Admittedly, there is alot in this ultimate guide and some of the material gets fairly technical. However, we did not design this guide for you to read cover to cover. Rather, it is more like a reference guide with short and concise articles that cover topics specific to the most common questions that we get at the firm.
As always, our tax law firm is about trying to help people and we are always here if you have questions or need further assistance. One of the reasons that we publish these resources is to help not only our clients, but anyone who is in need of a helping hand.
Thank you in advance for reading “Tax Attorney in a Box: The Ultimate Guide to Innocent Spouse Relief, Divorce, and Taxes." It was a labor of love and our law firm welcomes all questions, comments, concerns, and feedback that you may have about this free resource.
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Frequently Asked Questions about Divorce and Taxes
As a starting point in our guide, we wanted to briefly discuss some of the most common questions that we get in our practice. Some of these topics are covered in greater detail in later sections, but for quick reference we wanted to put them front and center in order to get some of the more pressing questions that you may have.
How do you file my taxes after you get divorced? Am I married or single?
- If you have received the final divorce decree by the last day of your tax year, then you are considered unmarried for the entirety of that year. The same applies for those who have received a separate maintenance (legal separation); if it is received before the last day of your tax year, you are considered unmarried for the whole year. As an unmarried person you can file as: single, head of household, or qualifying widow(er) file status (if applicable requirements are met)
Do I have to file taxes with my husband or wife if we are separated?
- As a married person, unless you have obtained a divorce decree of legal separation by the last day of your tax year, you must file as either: married filing jointly or married filing separately. However, if you are separated from your husband or wife for more than 6 months and have a qualified dependent you can file under head of household status.
How do I file taxes if the divorce is not finalized?
- Your marital status under state law as of December 31st controls your status for that entire year. If you have not received a final divorce decree by New Years Eve, the IRS considers you to be married for the entire year. As a married person, you have two choices to file under: married filing jointly or married filing separately.
Should I file head of household in the year I file for divorce?
- Filing head of household may provide some advantages to filing as single or married filing separately: your standard deduction is higher, tax rate is usually lower, and you may be able to claim certain credits (dependent care credit and the earned income credit) otherwise unavailable.
However, you should only file head of household in the year you file for divorce if you obtain a final divorce decree or have been separated for more than 6 months, and you have a qualified dependent. Otherwise, you must file as married filing jointly or married filing separately.
Who can claim children as dependents?
- Before you can claim a child as a dependent, be sure that they meet the qualifying child tests. Here are the requirements:
- The Relationship Requirement–––The child must be your son, daughter, stepchild, foster child, brother, sister, half-brother, half-sister, stepbrother, stepsister, or a descendant of any of these people
- The Age Requirement––– The child must be under the age of 19 at the end of the year (and younger than you). There are two exceptions to this rule:
- You may claim a child as a dependent who is under the age of 24 at the end of the year if they are a student; or
- Any age if that person is permanently and totally disabled
- Residency Requirement––– The child must have lived with you for more than half of the year (there are exceptions which exist for children of divorced or separated parents who live apart)
- Support Requirement––– The child must not have provided more than half of his or her own support for the year
- Qualifying Child of More Than One Person––– This is usually applicable to children of divorced parents. You must use the IRS “tie breaker rules” to determine which parent may claim the child as a dependent in the case that both otherwise qualify to do so (See page 11 of IRS Publication 501 for the tiebreaker rules).
What is the tax treatment of alimony and child support?
- Alimony is a payment made to a spouse who is entitled to receive that payment under a divorce or separation agreement. For this reason, any voluntary payments that are not made under a divorce or separation agreement would not count as an alimony payment. Additionally, a payment under such an agreement can only be considered alimony if the spouses do not file a joint return with each other and the following requirements are met:
- The payment is in cash (debit is acceptable too);
- The agreement does not designate the payment as not alimony;
- The spouses are not members of the same household at the time payments are made (only applicable if the spouses are legally separated under a decree of divorce or a legal separation agreement); and
- The payment is not treated as child support Prior to the Tax Cuts and Jobs Act of 2017 (TCJA), alimony payments were deductible from the income of the payer (excluded from the alimony-payer’s taxable income). However, the recipient (present or former) spouse would then be required to include the payment as taxable income.
On the other hand, the party who pays child support is not able to deduct the child support payments from their income and the receiving party does not include the payment in their taxable income.
TCJA has essentially reversed the stage at which tax is collected for alimony, making its tax treatment just like child support. Alimony payments are no longer deductible to the payer and no longer required to be claimed in the taxable income of the recipient).This is in effect as of January 1, 2019.
Although the tax treatment for child support has not changed (meaning alimony and child support are treated the same), there has been another tax change which parties to child support agreements may find significant.
The Tax Cuts and Jobs Act has done away with personal and dependent exemptions. This may be relevant to your situation if your existing agreement or order contains a provision which establishes which parent may declare minor children as personal/dependent exemptions on their tax returns, as many do. As of January 1, 2018, these provisions in your agreement no longer matter.
Regardless of which parent gets the right in the agreement, neither parent will be able to declare any children as exemptions on their federal return because as of January 1, 2018 due to the elimination of personal/dependent exemptions.
What is the taxability of property transferred in a divorce?
- Under Chapter 26 U.S. Code §1041, no gain or loss will be recognized on transfers of property between spouses or incident to divorce. In other words, a transfer of property relating to divorce can generally be completed tax-free. That said, the Code restricts transfers that are “incident to divorce” to mean (1) the transfer occurs within 1 year after the date on which the marriage ceases, or (2) the transfer is related to the cessation of the marriage.
In practice, this means that if the transfer takes place within a year it is tax-free no questions asked.
If the transfer occurs at some point past the year marker (but before the divorce’s six-year anniversary), you are not completely out of luck; however you will likely have to jump through some evidentiary hoops to prove that the transfer was related to your divorce. This means that if the transfer was not included in your divorce agreement, you may need to modify it to avoid tax liability if the transfer occurs between the first and sixth anniversary of divorce.
After six years, a tax-free transfer is not totally impossible but considerably more difficult because there will now be a presumption working against you that the transfer of property has nothing to do with the divorce. At that point, there really must be extenuating circumstances such as business or legal disputes relating to the property which explain why the transfer could not occur sooner.
Can I deduct my legal fees for a divorce? What if part of it has to do with my business?
- Legal fees for a divorce are considered a personal deduction. The Tax Cuts and Jobs Act eliminated personal deductions for 2018 through 2025. Although the eliminating provisions will “sunset” (go away) at the end of 2025. Until then, you cannot deduct legal expenses for your divorce, even if a result of the legal proceeding is the loss of income-producing property.
What is community property and how does it impact my tax filings?
- Community Property is a concern for married individuals who are domiciled in a community property state. Although there could be a distinction between where you are domiciled and where you currently live, for many individuals the two are one in the same.
Community property affects a married person’s rights and interests in property under state law. Community property can generally be described as all property acquired during marriage that is not otherwise established as separate property. Each spouse has a 50% interest in community property, without regard to who acquired the asset or income deemed that falls under the community property estate.
This is in contrast to separate property. Separate property is generally defined as property acquired before marriage; or during marriage through gift, inheritance, or an award for personal injury damages. These are not hard and fast rules, and we strongly recommend that you look to your state’s laws or speak to qualified counsel for advice on the characterization of property.
Whether property is characterized as community or separate has significant implications on how you must file your taxes, if you married filing separately. Spouses may have both community and separate property, respectively.
To complicate matters a bit further, a single item of property may contain an interest that is owned by the community property estate and an interest that is owned as separate property. Because assets can change from separate property to community property under certain circumstances, it may be difficult to figure out how to report any income earned or asset appreciated under community property.
In order for each spouse to report and pay their share of tax liability, you will need to determine exactly what interest each person has in the property.
For spouses filing a joint return, whether property is characterized as community property is less significant. This is because spouses who file a joint tax return are joint and severally liable for the tax on all of the income reportable, regardless of whether it is community property or separate property.
Because this means that your own personal assets could be used to pay the entire liability stemming from a joint return, you may want to take this into consideration when deciding whether to file jointly or separate.
How are retirement accounted treated for tax purposes in a divorce? (Pub. 504)
- Retirement plans can be a complicated topic, due to what some consider legislative oversight on the penalty consequences resulting from a mandatory family court order to access retirement funds in order to pay a former spouse.
Additionally, there are community property issues at play if the working spouse had funds in their retirement account before getting married and continued to accumulate funds in the account after marriage. In that case, part of the account may be separate property, whereas the rest may be considered community property; or all may be considered community property depending on the circumstances (for example, some event triggered “transmutation” or change of the separate property to community property).
There may be penalties involved in accessing these funds early, even in compliance with a court order. The IRS has recognized the unfairness, and have given out Private Letter Rulings (PLRs) which have helped taxpayers who would have otherwise taken a large hit on their hard-earned retirement funds.
Technically, PLRs are not supposed to be a source of authority to rely on. However, there have been quite a few on this topic which may give a taxpayer in this position room to avoid the penalty. Before withdrawing funds, you should be sure to have a Qualified Domestic Relation Order (QDRO) prepared.
The court will execute the QDRO, and send it out to the administrators of your Retirement Plan. This should help you avoid the 10% surtax penalty for those who withdraw funds early (usually before the age of 59 and a half). Because of the potential stakes involved, we strongly suggest you seek experienced counsel to guide you through the process.
How are property transfers treated in a divorce? (Pub. 504)
- Property transfers between a spouse or former spouse relating to divorce, is generally treated as a gift. There is no recognized gain or loss, which means no tax liability in most cases. Although you must still report the transaction on a gift tax return. However, there are specific restrictions as to what qualifies as a transfer related to divorce.
You should always try to complete the transfer within 1 year of obtaining the final divorce decree, unless there are extenuating circumstances which prevent the transfer; such as litigation with regard to the property, for example.
What happens to tax debt in a divorce?
- If the tax debt stems from a joint return, the IRS can pursue either spouse or both for the entire amount owed. Under certain circumstances, you may qualify for relief. Options for those who qualify may include relief from all or some of the liability. Alternatively, you may be eligible for allocation or separation of liability in some cases so that you may only be responsible for your share of the liability. For further information, take a look at our guide for managing tax liability incurred before or after a divorce.
What happens if we owe taxes while getting divorced and my husband or wife stops paying?
- Tax liability stemming from a joint return has joint and several liability. In other words, the IRS could hold you responsible for taxes, penalties, and interest resulting from the joint return. You may however qualify for relief under the Innocent Spouse Statute, Allocation of Liability provision, or Equitable Relief provision. Refer to the above article, or reach out to schedule a consultation with Senior Counsel at Brotman law for further assistance with your tax issue.
I suspect that my spouse cheated on our tax returns while we were married. How do I handle this now that we are getting divorced?
- Cheating on tax returns can potentially lead to criminal fraud charges. Because the liability under a joint return is joint and several, you may face charges as well depending on your level of knowledge, or what the IRS determines you should have known regarding your spouse's actions.
If you suspect your spouse is involved in tax fraud, it may be wise to reach out to an experienced tax attorney as early on in the process as possible. A tax attorney may give you peace of mind, or lessen your vulnerability to liability or criminal charges stemming from your spouse or former spouse’s actions.
What You Will Learn
This guide is made to help individuals navigate the issues of tax liability that relate to divorce. We realize that tax implications are not exactly at the forefront of our thought process when contemplating divorce; however, for many spouses it can be a driving issue and should be. We hope this ultimate guide alleviates your search for answers. Should you need further guidance, feel free to call the experienced divorce and innocent spouse relief attorneys at Brotman Law to set up a consultation with our experienced and knowledgeable Senior Legal Counsel.
Specifically, this guide will cover the tax implications of transferring property from one spouse to the other; and help lead you toward a tax-efficient strategy to split assets in your divorce. This includes the potential landmines which can be avoided when dividing up Retirement Plan benefits.
Additionally, this guide covers the tax implications you should be aware of if you are currently in the process of negotiating a structured alimony settlement. This section is especially relevant for individuals who currently have an alimony agreement in place which was finalized before January 1, 2019; as there have been noteworthy changes in this area under the Tax Cuts and Jobs Act. Depending on the applicability of the changes to your financial situation, you and your former spouse may wish to consider a modification to your previous agreement in order to take advantage of the current law.
If you are newly divorced but were married for part of the year; you may be unsure of your filing status. This guide also explains which filing status you are permitted to file under for those who are currently married; legally separated; or divorced.
Lastly, the guide addresses the relief options available to a qualified spouse or former spouse facing tax liability incurred by the other spouse during the course of their marriage. The corresponding section includes an in-depth discussion on what the applicable qualifications are for Innocent Spouse Relief; as well as the lesser known alternative relief options available under Separation of Liability Relief and Equitable Relief.
How is Alimony Taxed in a Divorce?
In any case, unless the split with your spouse happened before the 2019 Tax Cuts and Jobs Act, alimony payments and taxes have gotten only more involved and expensive. This chapter should shed light on the new rules.
How Do I File My Taxes If I Am Getting Divorced?
In this chapter, I will discuss the pros and cons of filing your taxes individually or jointly during divorce. You will find there are some exceptions for extenuating circumstances and some arduous facts that you should quickly acquaint yourself with.
Am I Eligible for Traditional Innocent Spouse Relief?
Many of us know people going through divorce who have discovered that “I love you,” doesn’t always mean “You can trust me.” If you filed a joint tax return with your ex and now unwittingly owe the IRS, I have written this chapter to help you ascertain your eligibility for Innocent Spouse Relief.
What Is Innocent Spouse Relief [Definition & Types]
There may be as many scenarios about one spouse being left burdened with tax debt after the death of the other or, more commonly a divorce, as there are being-left-at-the-alter tragedies. It happens far too often and causes more suffering after the spouses separate. This chapter will address what Innocent Spouse Relief is, how and when it should be used, and the types that can be applied to specific situations.