If you are going through a divorce, it is critical for you and the professionals working with you to keep an eye on tax issues that could save or, if you are not careful, cost you in the long run. Here are a few key issues to think about when negotiating your divorce settlement that could help minimize your tax burden at tax time next year.
Determine the most advantageous filing status. During the pendency of a divorce, the question is often raised as to whether to file jointly with your current but soon to be ex-spouse. Filing a joint return can result in potential benefits, such as utilizing a lower tax rate, but there are also potential pitfalls to watch out for. For example, when a joint return is filed, both spouses are jointly and severally liable for all taxes owed on the joint return (which means that, if your spouse does not pay his or her taxes, you are equally liable for any taxes owed). In addition, if one spouse has an outstanding individual state or federal tax debt, the IRS can utilize all or part of the joint refund to offset the debt. If you have concerns about filing jointly with your spouse, one option is to enter into an agreement with your spouse prior to filing setting forth how liabilities and refunds will be handled. You also can agree that one of you will indemnify the other from any liability; however, be aware that, even with such an agreement, the IRS can still collect unpaid taxes as well as interest and penalties from either spouse. Prior to entering into any agreements, consult with your divorce attorney so that you can make an informed decision about your filing status.
Minimize capital gains on the sale of the marital home. Many divorce settlements are structured around one spouse continuing to reside in the marital home with the scheduled sale of the home at a future date in time. If the marital home has appreciated significantly in value since its purchase, there may be capital gains taxes owing at the time of sale. Subject to satisfaction of IRS eligibility requirements, the amount of the capital gains exclusion is $500,000 if, at the time of sale, the spouses are married and filing jointly or if, after divorce, the home is jointly-titled in both parties’ names. However, after divorce, if the home is titled solely in one party’s name at the time of sale, the exclusion is only $250,000. Given this significant difference, it is important to consider the capital gains exclusion when structuring the provisions of your agreement relating to the marital home. Sometimes spouses agree to continue jointly owning the marital home for a few years after divorce while one spouse lives in the home so they can still take advantage of the $500,000 total capital gains exclusion upon sale (with each spouse individually excluding up to $250,000 of gain). However, if the spouse who is not staying plans on purchasing a new home, continuing to jointly own could impact his or her ability to qualify for a loan. Before deciding what to do with the marital home, talk with your family law attorney about creative options that minimize capital gain taxes.
Consider the tax advantage of temporary alimony during your negotiation. Through payments of alimony, taxable income can be shifted from the higher-earning spouse to the lower-earning spouse. This is particularly helpful in situations where there is a significant income disparity between spouses. However, in order for alimony payments between spouses to qualify as deductible alimony pursuant to IRS regulations, they must be made pursuant to a written agreement. Often, it takes time for spouses to negotiate and execute a final marital settlement agreement, which means that during the negotiation period, cash flow is often tight. Consider entering into a temporary written agreement regarding alimony payments as soon as possible during your negotiations, rather than waiting until all terms are agreed upon. Doing so could potentially improve the cash flow available to support the family.
Know what attorneys’ fees are deductible. Although most legal fees incurred to obtain a divorce are not deductible, in certain instances, you can deduct legal fees you pay to obtain alimony or that you pay for tax advice in connection with your divorce. When next year’s tax deadline is approaching, be sure to consult with your divorce attorney to determine whether a portion of his or her fees – or fees for other professionals who you consulted with including appraisers or accountants – are deductible.
Spotting and proactively addressing tax issues during your negotiations can make all the difference in how advantageous your divorce settlement is for you and your family. The Family Law Group of Feldesman Tucker brings experience, compassion, cutting-edge knowledge, and skills to understanding – and securing – what you will need in the years ahead. Contact us for more information on how to manage complex tax or financial issues related to divorce.