Divorce Tax Services:
Are you separated from your spouse and getting a divorce? don’t know if you should file your taxes as married or single?
I’m Married, but Separated… What is My Filing Status?
If a husband and wife obtain a final decree (order) of divorce on or before 12/31, then they are considered as being unmarried for that entire year. The result is that they must file as Single or Head of Household. Of course, if they were still married after 12/31, then they could file as Married Filing Jointly or Married Filing Separately. However, there is one exception to this latter rule, which allows a married person to file Head of Household if the other spouse did not live in the home for the last 6 months of the year and the spouse claiming Head of Household status paid more than one-half of the cost of maintaining the home as the principal resident for the child or children. The other spouse then must file as Married Filing Separately.
Tax Exemptions & Credits
The impact of a person’s filing status also affects other tax issues. The custodial parent is not only able to file as Head of Household, but also may be eligible for the Earned Income Credit. The custodial parent is also entitled to the dependency exemption. There is a link between the dependency exemption and the Child Tax Credit. The Child Tax Credit can only be received by the person who claims the dependency exemption. Therefore, the dependency exemption and the tax credit cannot be split between the parties.
Also, the Earned Income Credit and the Additional Child Tax Credit are refundable credits. This is important in bankruptcy cases (especially Chapter 7 cases) because tax refunds are bankruptcy assets, and these two refundable credits protect that portion of the taxpayer’s refund when determining what, if any, portion of the tax refund is required to be turned over to the trustee.
Spousal Support (Alimony)
Spousal support is treated as taxable income to the spouse receiving the support and deductible to the spouse paying the support. You would want to know the tax consequences of spousal support to effectuate a better divorce or dissolution settlement or to have ready for the divorce trial.
Transfers of property, including a marital residence, from one spouse to the other spouse are generally non-taxable events. These spousal transfers incident to a divorce are treated like gifts. The spouse who receives the property receives an adjusted basis in order to compute the gain or loss on the future transfer of the property. It is also important to know that pursuant to the Tax Reform Act of 1997, there is a $250,000 exclusion of capital gain per spouse ($500,000 per couple) on a principal residence sold after May 6, 1997 provided that the spouse or couple resided at the residence for 2 out of the last 5 years.
Sale of stock and liquidation of retirement accounts are taxable events where many clients encounter tax problems. On the sale of stock, taxpayers fail to account for the adjusted basis in the stock to determine the true recognition of gain or loss. And many tax clients who liquidate their 401(k) or individual retirement accounts do not withhold enough (if any) federal or state income taxes and they fail to account for any penalties associated with the early withdrawal. At Sheppard Law Offices, Kenneth L. Sheppard, Jr. assists these clients by amending their tax returns to correct the deficiencies.
Tax Liability Issues
Spouses have individual, not joint, interest in tax refunds. Unless otherwise agreed, the overpayment is allocated between the couple according to the amount of tax paid by each spouse.
The “Innocent spouse” rules allow a spouse to apply to the IRS to disengage from filed joint tax returns and to obtain protection from joint liability, if he or she suspects that the other spouse has not been honest in filing the joint tax returns.
The rule provides that where the parties have filed a joint return, and where as a result of the gross misstatements of one spouse, there is an understatement of tax due, and where the innocent spouse can demonstrate that he or she signed the tax return not knowing about the understatement, then the innocent spouse will not be responsible because it would be inequitable to hold the innocent spouse liable for the deficiency taking all the circumstances into consideration. There are time limitations for filing with the IRS for innocent spouse protection.
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