Q. If my husband and I are
separated but not divorced, do we have to file a joint tax return?
A.
No, even married taxpayers who are living together are not required to file
joint returns, but only married taxpayers are eligible to file joint returns
if they so desire. For tax filing purposes, you are considered unmarried if
a final divorce decree was entered by the last day of the tax year. There
may be both advantages and disadvantages to filing separately. For example,
spouses who file separate returns report their own incomes. However, if one
spouse itemizes deductions, the other must also itemize and cannot claim the
standard deductions. The best idea is to make the decision about filing
separately or jointly, if you are entitled to do so, after discussing with
your tax advisor the best way to minimize the tax paid to "Uncle Sam." You
and your spouse may agree to file jointly, if that is most advantageous, and
then provide a method for sharing the tax savings (or dividing the
liability).
Q. Who gets to claim the kids?
A. For parents who are
divorced, separated under a written separation agreement, legally separated
under a court order, or who lived apart at all times during the last six
months of a calendar year, the parent who has custody of the children for
the greater portion of the year (the custodial parent) is generally entitled
to claim the dependency exemption. However, the non-custodial parent may
claim this exemption if there is a court order or separation agreement that
gives that parent the unconditional right to claim the exemption or
if the custodial parent releases the exemption to the non-custodial parent
by completing IRS Form 8322 and attaching it to his or her tax return. Where
parents are in different tax brackets, it often makes sense to transfer the
exemption to the parent in the higher tax bracket (although individuals in
the highest income bracket have all exemptions phased out and disallowed).
This can be a good bargaining chip in the hands of a custodial parent in a
lower tax bracket. In addition, a provision in a separation agreement which
provides that the custodial parent will transfer the dependency exemption to
the non-custodial parent if that parent is current in all child support and
related obligations by the end of each year can be a good incentive for the
non-custodial parent to stay current with his or her child support
obligations.
Q. What’s so important about
the dependency exemption anyway?
A.
The dependency exemption reduces your taxable income and consequently
decreases the amount of taxes you pay. For the 2005 tax year, the amount of
the dependency exemption is $3,300 for each dependent. The ability to claim
at least one dependent is also important in determining whether you can
claim "head of household" status which results in a lower amount of tax owed
and a higher standard deduction than if your filing status is "single." In
addition, there is a child tax credit of $1,000 for each child under the age
of 17 and this important credit is linked to the dependency exemption. Only
the parent eligible to claim the child as a dependent can take the tax
credit for that child. This tax credit is subtracted directly from the
amount of taxes you have to pay. The dependency exemption is also important
in determining which parent can claim the new education credits which may be
available for expenses paid for a child’s post-secondary education. Caution:
the dependency exemption, child tax credit and education credits all have
high-income phase-out provisions which must be considered in determining
whether you are eligible for these tax benefits.
Q. Will I have to pay taxes on
the child support I receive?
A.
No. Child support is not taxable to the person receiving it and is not
tax-deductible to the person paying it. Therefore, $600 a month received in
child support is actually $600 "in your pocket" which you will be able to
spend on expenses without having to worry about taxes.
Q. I am a dependent spouse and
I have figured out that I
will need an extra $1,000 per month in order to
pay my monthly expenses. If I get $1,000 a month in alimony, I’ll be able to
pay all my bills, right?
A.
Wrong. Don’t forget that alimony, unlike child support, is taxable as income
to the recipient and tax-deductible for the payor. In order to determine how
many "real dollars" you’ll have to pay expenses each month, you need to
consider your tax liability on the alimony you receive. For example, if you
are in the 15% tax bracket, you will need to receive $1,176.47 in alimony to
have $1,000 available after taxes (since you would pay $176.47 in taxes on
that sum of alimony). On the other hand, if you are the person paying
alimony, you will want to consider the tax benefit you’ll get from the
payments of alimony in determining the "out-of-pocket" effect of such a
payment. For example, if you are paying $1,000 per month in alimony and you
are in the 31% tax bracket, you will in effect be "out-of-pocket" $690 per
month because you will get a tax deduction of $310. Caution: the tax effect
of alimony described here depends on the payments meeting the IRS definition
of alimony. This means that the payments:
-
Must be in cash;
-
Must be made pursuant a divorce or separation instrument, i.e., a court order for spousal support or a written separation agreement;
-
Must not be made while the spouses are members of the same household;
-
Must end upon the recipient’s death;
-
Must not be disguised property division or child support payments; and
-
Must not be designated as a payment which is "not includable in the gross income of the recipient and not allowable as a deduction by the payor."
Q. My spouse and I have agreed
to sell our home so that we can each get our share of the equity in it. What
will I have to pay in capital gain taxes?
A.
Probably nothing. The Taxpayer Relief Act of 1997 changed the law
drastically as to capital gains on the sale of a home. No longer do
taxpayers need to roll over the sale proceeds into another home to avoid
capital gain taxes. Under the new law, regardless of age, each taxpayer can
exclude up to $250,000 in capital gains ($500,000 for joint return) on the
sale of the marital residence which has been owned and used by the taxpayer
as his or her principal residence for two out of the five years prior to the
sale. The spouse who acquires ownership of the house related to the divorce
or separation can tack on the transferring spouse’s period of ownership to
his or her own. This is good news for a taxpayer who didn’t qualify for the
exclusion under prior law because he or she moved out of the marital
residence leaving the other spouse in possession.
Q. Now that I’ve read your
client information letter on tax considerations, I don’t need to consult a
tax specialist, right?
A.
Wrong. The tax laws are complicated and have implications far beyond what
can be addressed in this client information letter. The general information
set out here is not a substitute for consulting with a tax professional. He
or she can provide invaluable assistance to you in identifying tax
consequences and developing strategies to minimize the negative consequences
of your particular situation.
DB Publishing