A divorce or separation is a life-changing event, one has to deal with many life changes such as readjusting their finances, taxes and other-related aspects that can often slip the mind. A divorce can bring certain changes to a taxpayer’s tax situation and if not addressed in time could lead to unwanted tax problems.
The following is a brief overview of certain key factors to keep in mind that can impact filing taxes after divorce. Nonetheless, it is always recommended to consult a US tax professional regarding taxes after divorce to be prepared when filing the annual federal US income tax return.
Change in Tax Filing Status after Divorce
Under U.S. tax laws, a couple is considered married for the whole year if they are separated but have not obtained a final degree of divorce or separate maintenance by December 31. Therefore, both taxpayers can either choose to file as ‘married filing jointly’ or as ‘married filing separate’, the tax statuses ‘Single’ and ‘Head of Household’ may be used only once the divorce is finalized. Taxpayers that lived apart from his/her spouse, under certain circumstances, may file as head of household..
Although filing joint may result in lower taxes, it could be risky as both the spouses are liable for each other’s unpaid taxes. The IRS provides Innocent Spouse Relief to a spouse that was not aware of the financial activities of their spouse and how he/she was understating (or underpaying) their taxes.
Divorced couples choosing to file separately should be aware that they are both required to claim either standard deduction or itemized deduction. If claiming itemized deduction, expenses such as mortgage interest should be claimed only to the amount paid by them individually. Other qualifying expenses paid from joint accounts may be split equally. Earned income tax credit (EITC) and certain education tax credits cannot be claimed ‘married filing separately’.
Exemption for Dependents In most cases, a child of divorced or separated parents is the qualifying child of the custodial parent. However, the custodial parent may agree to let the spouse claim the child as a dependent exemption. To do so, the custodial parent must sign form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent. Determining who the custodial parent is can sometimes be difficult in the case of shared custody. However, it is important to determine as this effects not only who can claim exemption for the child but also who will receive other benefits such as the child tax credit, the child care credit, head of household status, etc.
Change in Last Name
If the spouse had legally changed her last name after marriage, this information needs to be updated with the Social Security Administration (SSA) by filing Form SS-5, Application for a Social Security Card. If there is any discrepancy in the information provided on the tax return and the SSA, it could result in putting the filed return on hold, and delay the processing of any expected refund.
Divorce Alimony Paid
Alimony amount paid by the former spouse under a court order/divorce ruling qualifies as a deductible tax expense. The spouse incurring the expense would need to provide the Social Security Number (SSN) or (ITIN) of the spouse receiving the alimony benefit on their Form 1040, Individual Annual Income Tax Return. Any other amount paid voluntarily to the former spouse, even if it is on a regular basis, is not deductible if it is not ordered by the court.
Divorce Alimony Received
Alimony received is considered ‘earned income’, and should be reported on the annual income tax return. Since no tax is withheld on alimony income, it is recommended to make or increase the estimated tax payment during the year, or increase the tax withholding by the employer to cover the taxes that would be applicable on the alimony to avoid any tax interests and penalties.
Child Support Payments
Any amount paid to the spouse who has custody is considered to receive ‘child support payments’. It could be a minimum amount ordered by the court, but even then child tax payments cannot be claimed as tax deductions by the spouse paying them, nor is child support payments considered taxable income to the spouse receiving them.
Spousal Individual Retirement Account (IRA) after Divorce
If the divorced couple held a spousal IRA then the spouse contributing into the spousal IRA cannot claim these IRA contributions as tax deduction once the final divorce decree is provided by the court.
Property Settlements Generally, there is no recognized gain or loss on the transfer of property between spouses, or between former spouses if the transfer is because of a divorce. You may, however, have to report the transaction on a gift tax return. If property sold was owned jointly, each spouse must report their share of the recognized gain or loss on their income tax return for the year of the sale.
Update Existing Joint Shared Group Benefits and Policies after Divorce
Along with updating the insured and beneficiary status for employer-paid group benefits and insurance, the divorced couple would need to update any existing joint healthcare policies. The policy amount should be distributed between the spouses and reported on their respective individual annual income tax returns.
Report Changes for Existing Health Insurance Plans
Health insurance purchased from Health Insurance Marketplace could result in advance payments of the Premium Tax Credit. However, individuals getting divorced should consider updating the information provided to the Marketplace. This could be change in address, change in name, change in marital status, change in income, change in family size, etc. Updating the information provided to the healthcare insurance marketplace is important as this will assure that the coverage is re-evaluated and proper coverage and financial assistance is provided.
Obtain Required Minimum Health Care Insurance Coverage
Under the Affordable Care Act (ACA), every individual in the U.S. should have the required minimum healthcare coverage for themselves and the dependents claimed on their annual U.S. income tax return. If the divorce leads to a spouse losing their existing coverage, it is important that they consider obtaining the required minimum health insurance coverage through Healthcare marketplaces during the special enrollment period.
Expenses Incurred as Legal Fees & Tax Advice Fees
Although the amount paid to the divorce lawyer is not tax deductible, however, amounts paid to assist in obtaining alimony may be deductible. In addition, any fee paid to appraisers, actuaries, and accountants for services in determining your correct tax federal, state and local tax may be tax-deductible, provided the person is claiming ‘Itemized Deduction’ on their Form 1040: U.S. Individual Income Tax Return. It is important to provide valid documents in support of this tax claim, therefore, if the fee is comprised of deductible and non-deductible charges, an individual should ask the tax professional for a breakdown of the fee on the invoice.
AG Tax LLP Can Help
If you have any tax-related queries or need assistance with tax planning or filing please contact AG Tax. Our tax professionals are highly-experienced with U.S. and Canadian tax laws and can provide you the right guidance to handle your tax situation.
Aylett Grant Tax LLP is a full service accounting firm with a dedicated team of experts, who are highly-qualified and experienced in handling situations related to U.S., Canada and other international tax laws.
We can assist with:
• Canadian Personal and corporate tax returns
• Cross Border Taxation and Business Planning
• U.S. Personal and Corporate Taxation
• Disclosure of Foreign Assets and other information filings
• Retirement planning
• Estate Planning, Inheritance tax advice
Please contact either of our offices in Canada at 604-538-8735 (Greater Vancouver), or 780-702-2732 (Edmonton and Alberta) to arrange for an appointment to discuss your tax related queries.
Disclaimer: The information in this publication is accurate as of the time of its publication. AG Tax assumes no responsibility for changes to tax legislation subsequent to the publication of this document. The information provided is for general information purposes only and should not be acted upon without seeking professional advice. If you would like to engage our services, please contact our staff and obtain authorization to send our firm confidential information. A client relationship is not created by the transmission of information. A client relationship is only formed with our firm when a scope and engagement letter signed by the firm and the potential client detailing the terms of engagement is present.