If you are recently divorced or are contemplating divorce you will have to deal with or plan for significant tax issues...
If you are recently divorced or are contemplating divorce you will have to deal with or plan for significant tax issues such as asset division, alimony, and tax-return filing status. If you have children, additional problems include child support, claiming the children as dependents, the child/children, child care, education tax credits, and perhaps even the earned income tax credit (EITC).
Your marital status at the end of the year will determine your filing status. For example, suppose on December 31, you are in the process of divorcing but are not yet divorced. In that case, your options are to file jointly, or you each submit a return as married filing separately. However, there is an exception to this rule. For example, if a couple had been separated for the last six months of the year, and one taxpayer has paid more than half the cost of maintaining a household for a qualified child. That spouse can use the more favorable head of household filing status. If each spouse meets the criteria for that exception, they can both file as heads of household. Otherwise, the spouse who doesn’t qualify must file using married filing status separately. On the other hand, suppose your divorce has been finalized, and you haven’t remarried. In that case, your filing status will be single, or if you meet the requirements, head of household.
Claiming the Children as Dependents
A common (and commonly misunderstood) issue for those divorced or separated and who have children is choosing who claims a child for tax purposes. This can be a hotly disputed issue between parents; however, tax law includes very specific (albeit complicated) rules about who profits from child-related tax benefits. At issue are several benefits, including the child, child care, higher-education tuition, earned income tax credits, and, in some cases, filing status.
This is one of the most complicated areas of tax law, and both taxpayers and inexperienced tax preparers can make serious mistakes when preparing returns. This can be especially true if the parents are not communicating well. However, when parents cooperate, they often can work out the best tax result overall, even though it may not be the best for them individually. They can then compensate for discrepancies in other ways.
When a court awards physical custody of a child to one parent, the tax law is particular in awarding that child’s dependency to the parent who has physical custody. The amount of child support that the other parent provides does not affect this. However, the custodial parent may release the dependency to the noncustodial parent by completing the appropriate IRS form.
CAUTION: The decision to relinquish dependency should not be taken lightly, as it impacts several tax benefits.
On the other hand, if a court awards joint physical custody of a child, only one of the parents can claim the child for tax purposes. If the parents cannot agree on who will claim the child, or if both claim the child, the IRS tiebreaker rules apply. Per these rules, a child is treated as a dependent of the parent with whom the child resided for the greater number of nights during the tax year. If the child resides with both parents for an equal amount of time, then the parent with the higher adjusted gross income claims the child as a dependent.
These rules take precedence over what a court may intend. For example, say the judge in Tom and Becky’s divorce proceeding rules that Tom is to claim their child as a dependent on his tax return. However, Tom is required to pay a specified amount of child support monthly, and the child lives with Becky more nights during the year than with Tom. Thus, under the tax law, Becky can claim the child as her dependent, regardless of what the court-approved divorce agreement says.
Under prior law, a child’s tax-exemption deduction was generally an issue; the parent claiming the child as a dependent got a deduction for the exemption allowance amount. However, because of tax reform, the tax deduction for such exemptions has been suspended through 2025. Although this is no longer an issue for this benefit, a child’s dependency is still considered for other tax issues.
Head of Household Filing Status
An unmarried parent can claim the more favorable head of household (rather than single) filing status if that person meets these two requirements:
The unmarried parent is the custodial parent.
The unmarried parent pays more than one-half of the cost of maintaining the household's principal place of residence for the child (i.e., where the child lives for more than half of the year).
Suppose the child qualifies for either two higher-education tax credits (the American Opportunity Tax Credit [AOTC] or the Lifetime Learning Credit). In that case, the credit goes to whoever claims the child as a dependent. Credits are significant tax benefits because they reduce the dollar-for-dollar tax bill. On the other hand, deductions reduce taxable income before the tax amount is calculated according to the individual’s tax bracket. For instance, the AOTC provides a tax credit of up to $2,500. 40% is refundable. However, both education credits phase out for high-income taxpayers. For years after 2020, both credits phase out between $80,000 and $90,000 for unmarried taxpayers and between $160,000 and $180,000 for married taxpayers.
Child Care Credit
A nonrefundable tax credit is available to the custodial parent to offset childcare costs, provided that the parent is gainfully employed or seeking employment. To qualify for this credit, the child must be under the age of 13 and dependent on the parent. However, there is a special rule for divorced or separated parents. When the custodial parent releases the child’s exemption to the noncustodial parent, the custodial parent still qualifies for the child care credit. However, the noncustodial parent cannot claim that credit. The credit is a percentage of the expenses. It ranges from 35% for lower-income taxpayers to 20% for the higher-income ones. The expenses used to determine the credit are limited to $3,000 for one child and $6,000 for two or more. Note: A substantial one-year (2021) increase in the credit is included in President Biden’s American Rescue Plan.
Child Tax Credit
A credit of $2,000 is allowed for each child under 17. This credit goes to the parent who claims the child as a dependent. Up to $1,400 of the credit is refundable if the credit exceeds the tax liability. However, this credit
phases out for high-income parents, beginning at $200,000 for single parents and $400,000 for married parents filing jointly. President Biden’s American Rescue Plan also includes a one-year increase to $3,000 ($3,600 for children under 6).
Earned-Income Tax Credit
Low-income parents with earned income (either wages or self-employment income) may qualify for the EITC, which is based on the number of children (all those under age 19, plus full-time students under age 24), up to a maximum of three children. Releasing dependency to the noncustodial parent does not disqualify the custodial parent from using children to qualify for the EITC. However, the noncustodial parent is prohibited from claiming the EITC based on children whose dependency the custodial parent has released.
The tax reforms enacted in late 2017 had impacted the tax treatment of alimony. For divorce agreements that were finalized before the end of 2018, the recipient (payee) of the alimony must include that income for tax purposes. The payer, in such cases, is allowed to deduct payments above the line (without itemizing deductions). This is referred to as an adjustment to gross income. The recipient who includes this alimony income can treat it as earned income to qualify for an IRA contribution, thus allowing the recipient to contribute to an IRA even if he or she has no income from working.
Some recipients who make alimony payments claim that they paid more than they did. Some recipients will also report less alimony income than they received. Due to these false claims, the IRS requires that the paying spouse’s tax return include the recipient spouse’s Social Security number. The IRS can then use a computer to match the amount received to the amount paid.
For divorce agreements that are finalized after 2018, alimony is not deductible by the payer. It is also not taxable income for the recipient. Because the recipient isn’t reporting alimony income, they cannot treat it as earned income to make an IRA contribution.
This revised treatment of alimony also applies to any divorce or separation instrument that is executed before the end of 2018 but modified after that date (if the modification expressly provides that the tax reform provisions apply).
As you can see, some complex rules apply to divorce situations. Please call this office if you have any questions related to a pending divorce action.