10 Income Tax Tips for Separated Couples

A separation is often a confusing time for couples … and that includes changing tax situations.
A separation is often a confusing time for couples … and that includes changing tax situations.

It started out as happily ever after, but after awhile the weight of daily life — unchanged toilet paper rolls, time-sucking commutes, unresolved injuries — began to crush your once-blissful couplehood. Frustrated, but not ready to call it quits, separating seemed like a natural solution.

You both know there are still many questions to be answered, except for one that became abundantly clear: Adjusting to this new normal would take time and work. You both discovered that disentangling a marriage is a complex and nuanced process that was taxing you to the limit. And then came the actual taxes.

Should you file together or separately? Who can — and who should — claim the children, the childcare or the new braces? What about pet expenses? Should you sell the house and split the profit? The truth is, dissolving a marriage can be taxing. But then again, so are taxes.

Understanding which tax moves could work in your best interest, and which could be all wrong for your situation, is an essential part of unraveling your relationship while remaining in good standing with the U.S. government.

10: Weigh Your Filing Options

You are estranged from your spouse and now it's time to file federal income taxes. Whether you are legally separated or are living apart informally, you can still prepare a joint return. It's an option you'll no longer have after you divorce.

However, just because you can file a joint tax return doesn't mean you should. There are other options that should at least be considered. Admittedly, filing a joint return will reap a larger standard deduction ($24,000 for tax year 2018). Or, you can file separately as head of household, which offers a $18,000 standard deduction. It's a decidedly more attractive option than the $12,000 available to those with a single or married filing separately status.

There are tax brackets to consider, too. If you have a married filing joint status, you and your spouse can remain in the 12 percent tax bracket until your combined earnings reach $77,400. The married but filing separately cap is just $38,700. If you file as head of household, you can stay in the 12 percent tax bracket up to $52,850 for a single income. Meanwhile, the 12 percent tax bracket for single filers is $38,700, the same as married filing separately. Go above these incomes and you'll find yourself in the 22 percent tax rate bracket. It pays to stay in the 12 percent category as long as you can [source: U.S. Tax Center].

9: Transfer Retirement Assets, Tax-free

A retirement account may not seem like a top priority during a separation, but if you don't fully understand the tax consequences of transferring assets, it can become a costly problem.

As part of your separation, some of your retirement earnings may go to your spouse (or vice versa). Failing to use the correct process could have significant tax implications. Take Jane, for example. She has been the primary earner most of the marriage, so she opted to give her estranged husband George 50 percent of her 401(k) so he could embark on a financially independent life.

Jane should have made the transfer using a qualified domestic relations order (QDRO), which would have allowed her to transfer or rollover the funds tax-free. Because she did not use a QDRO, the Internal Revenue Service taxed the distribution, leaving Jane with a hefty tax bill and an early withdrawal penalty.

Using a QDRO to arrange for the transfer of 401(k) or 403(b) retirement assets from one spouse to another allows tax-free access to the funds and avoids early withdrawal penalties. Similarly, to transfer or rollover retirement funds from an IRA, you'll need to make a "transfer incident to divorce," which offers the same tax benefits [source: Cussen].

8: Don't Double Up on Child Tax Credit

Children are a joy, especially when it comes to claiming a Child Tax Credit.

A Child Tax Credit can shave as much as $2,000 per child off your tax bill. If you and your estranged spouse are filing separately, you'll need to decide who will claim your child as a dependent. This determination will impact potential tax credits.

Only the parent who claims a qualifying child as a dependent will be eligible for a Child Tax Credit. To qualify for a Child Tax Credit, you must have provided at least half the child's support during the tax year and the child must have lived with you more than half of the tax year. Additional criteria must be met in order to qualify for a Child Tax Credit, which take into account a child's age, citizenship and relationship to a parent, so it may be in your best interest to consult a tax adviser.

Even if you meet all the criteria for a Child Tax Credit, you may earn too much money to receive it. A parent whose modified adjusted gross income is more than $200,000 typically won't qualify [source: Josephson].

7: Claim Child and Dependent Care Tax Credit

What if you aren't the spouse who gets to claim your child as a dependent and, therefore, potentially receive a Child Tax Credit? You can still get the credit you're due. Namely, a Child and Dependent Care Tax Credit as long as you meet certain criteria.

To qualify, your child needs to have been younger than 13 during the tax year, and you need to have paid someone else to take care of your child so you could work or go to school full-time. The Child and Dependent Care Tax Credit also may apply if you needed childcare to conduct a job search or if you have a dependent of any age with a physical or mental disability.

The amount of Child and Dependent Care Tax Credit you receive is based on the number of children you have and the cost of childcare. The tax credit could be up to $3,000 for one child or $6,000 for two or more children, so it pays to investigate the possibilities [source: IRS].

6: Deduct Paid Alimony

If you've entered into a separation from your spouse, odds are the term "alimony" has been bantered around. Alimony is money paid to a spouse (or former spouse) and, like most financial aspects of relationship dissolution, has tax consequences. In short, alimony is a tax-deductible expense if you pay it and can be taxed as income if you receive it.

There are a few specifics worth paying attention to as well. First, the alimony needs to be paid under a formal agreement. It doesn't count — at least for tax purposes — if you just call it alimony and don't have a written separation agreement in place that spells out how much you'll pay and when. In order to deduct alimony from your taxes, you and your spouse cannot live together. And, you'll need to file separate tax returns.

If you are paying a spouse to use or maintain property you own, it cannot count as an alimony deduction. For example, if you purchase a condo and move into it without your estranged spouse, and then hire your estranged spouse to remodel it, you cannot compensate your estranged spouse and expect to deduct it as alimony [source: IRS].