Income Taxes and Your Divorce

Kathryn A. McMahon

When getting a divorce, you should be certain to discuss with your accountant the various tax issues that need to be considered. Additionally, it is important that provisions related to your taxes are negotiated and included in your Marital Settlement Agreement or, if your matter goes to trial, raised with the Court. Although taxes are often overwhelming, tax season will be much easier if you and your spouse determine these common issues in advance[1]:

Filing Status: You and your spouse can file your taxes as married filing jointly or married filing separately so long as you are married on the last day of the tax year, December 31st (this is when your marital status is determined). This means that in the year you are divorced, you can no longer file jointly for that tax year. Therefore, the timing of the entry of the Judgment of Dissolution of Marriage should be considered. If you are filing jointly, you should also address how your tax refund will be divided or your tax liability will be paid. If you are receiving a refund, you should consider requesting a joint refund check or electronic deposit to a joint bank account rather than applying the refund to the following tax year as it will be applied to the first named taxpayer’s return.

Dependency Tax Exemptions: You and your spouse should determine how you are going to claim your child(ren) as dependency exemptions on your tax returns in the year you are divorced and subsequent years. Typically, if you have 1 child, you may agree to alternate the exemption in even and odd years; if you have 2 children, you may agree to each claim 1 until only 1 child is eligible, at which time you will alternate that child; and if you have 3 children, you may agree to each claim 1 child and alternate the third (the same concept is applied to additional children so as to share the exemptions). In some cases, you may may agree that if one of you does not benefit from the exemption(s) in any given tax year (e.g. you don’t have any income to report), you will have to inform the other parent who can then claim the exemption(s) that year. Further, in some cases, you may agree that one of you can claim all of the exemptions (perhaps because that party is providing all of the support for the child(ren)). You and your spouse should also agree to execute all documents necessary to implement your agreement including IRS Form 8332 (Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent).

Capital Gains Tax: You should discuss how you will divide any capital gains taxes you may incur as a result of the sale of any assets such as real estate, stocks, etc. When you divide investments accounts, mutual funds, stocks, etc., you should include language in your Marital Settlement Agreement that the assets will be divided “in kind,” which means that you transfer the assets without selling them first. This will ensure both parties are being awarded a share of all underlying assets with corresponding tax bases, and if party chooses to sell an asset after division, any tax consequences will be in his or her own name. 

Net Operating Loss Carryforwards and Capital Loss Carryforwards: You and your spouse may have net operating loss carryforwards or capital loss carryforwards from previous tax years. These may be subject to allocation depending on the circumstances. If you are being awarded assets that you may be able to claim such loss carryforwards against in the future, you may wish to be awarded a portion of the carryforwards, to the extent allowable by the IRS. If not allowable, you may be awarded an offset for the value of the carryforward being awarded to your spouse.

Deductions: You and your spouse should determine how you are going to claim deductions for joint property including, but not limited to, mortgage interest and real estate taxes. Typically, you may agree to share deductions for expenses paid while you are married and until you are divorced, after which time, the party who is being awarded the asset and is responsible for payments related to the asset may claim the deduction. For example, if you and your spouse are divorced in June and you are awarded the joint marital residence, you may agree for your spouse to deduct 25% of the mortgage interest and real estate taxes and for you to deduct 75%, if allowable (you split the deduction for the first half of the year, and you take the whole deduction for the second half of the year). Similarly, if you and your spouse agree to sell your marital residence and split the mortgage and real estate taxes until it is sold, you may agree to share the deductions. However, if one party is residing in the home and is responsible for such payments until the sale, you may agree for that party to claim 100% of the deductions incurred during that time, if allowable (and that party may often get a credit from the net sales proceeds for the reduction in mortgage principal incurred during that time). You should talk to your accountant about these joint deductions and any other joint deductions to determine whether and how they are allowed to be shared by the IRS. 

Amendments or Deficiencies to Prior Joint Tax Returns. You should address how you will handle any amendments or deficiencies to previously filed joint income tax returns. Typically, parties agree to cooperate with any amendments and share any joint refunds. Furthermore, parties typically agree to be equally responsible for any additional tax liabilities or deficiencies incurred as a result of information supplied by both parties but if a deficiency is assessed due to information supplied by one party, that party may be responsible for the deficiency as well as professional fees incurred.

Document Exchange: To the extent you and your spouse need to exchange any documents in order to determine the cost basis of any assets, you should include that in your Marital Settlement Agreement to avoid any disputes in the future. In addition, to the extent your or your spouse have an obligation to pay child support or maintenance (or such issues are reserved), you should include language that you will exchange your tax returns, year-end paystubs, and other specific, relevant documents by a date certain each year. This will also help avoid problems in obtaining such documents from your ex-spouse in the future.

[1] The attorneys at Katz & Stefani, LLC are not tax attorneys, accountants, or tax professionals, and accordingly, they cannot give tax advice. This blog is meant to summarize broad tax issues that commonly arise in divorce cases that you should further discuss with your attorneys and accountant depending on your specific facts and circumstances. Not all tax issues and concerns are addressed in this blog.