While we wish it weren’t true, divorce is a reality in our world. Divorce brings about tremendous and oftentimes hostile emotions. While this is a very trying time in a person’s life, there are a number of tax and financial issues to consider if you are in this situation.
Filing status
Filing status is affected by the marital status of the taxpayer, which is determined as of the last day of the tax year. Taxpayers who are considered married may file as married filing joint or married filing separate. If certain requirements are met, one spouse may file as Head of Household. Divorced taxpayers are jointly and individually responsible for joint tax returns filed prior to divorce. Taxpayers should weigh the benefits and detriments of both filing statuses before making the decision.
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Dependent rules
Taxpayers facing divorce or legal separation must consider the allocation of personal and dependency exemptions. Each taxpayer is allowed one personal exemption for him or herself unless he or she is a dependent of someone else. The dependent exemptions for children generally will go to the custodial parent unless the custodial parent signs a Form 8332. Frequently, one parent will benefit more than the other to claim the dependency exemption, thus the parties should negotiate the allocation that would result in most favorable overall tax consequences. This should include consideration of marginal tax rates, child tax credits, and child and dependent care credit.
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Alimony
Alimony is a payment to or for a spouse or former spouse under a decree of divorce or separation. Alimony is deductible by the payer and is taxable income to the recipient. Payments must meet certain requirements to be considered alimony:
- The payments are made under a divorce or separation instrument.
- The payments are made in cash.
- The divorce or separation instrument does not designate the payment as not alimony.
- The spouses are not members of the same household at the time the payments are made.
- There is no liability to make any payment after the death of the recipient spouse.
- The payment is not treated as child support.
Alimony includes cash payments to a third party on behalf of a spouse or former spouse required under the divorce or separation instrument. Examples include: rent, utilities, taxes, mortgage payments, and medical expenses.Life insurance premiums for a policy owned by the spouse, on the payer’s life, required under the divorce or separation agreement are also included.
The following payments are not alimony even if they are made under a divorce or separation instrument:
- Child support
- Noncash property settlements
- Property settlements
Revisit tax estimates and withholdings
Many tax attributes change after divorce. These changes may significantly impact the amount of taxes owed in the year following divorce. You should meet with your accountant to revise your tax estimates or withholdings. You should also consider how the refund or overpayment will be treated on the final marital return.
Insurance issues
Perhaps the most significant insurance change you should consider is health insurance. Generally we see one spouse being covered by the other’s health plan. You will need to review coverage after the divorce including the dependents. Determine if children must be dependents to be covered. Life insurance should also be reviewed. You will need to determine the appropriate amount of coverage after the divorce and will need to change the beneficiary. Don’t forget the group policies for which you have coverage. You should also review your disability policy to determine if you have the appropriate coverage. If the home changes title, you will need to make sure the property and casualty coverage is titled properly. MDA Financial Services can be a great resource in this area.
Read Part 2 of this article series.
