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 ($12,400 for tax year 2014). Or, you can file separately as head of household, which offers a $9,100 standard deduction. It's a decidedly more attractive option than the $6,200 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 15 percent tax bracket until your combined earnings reach $73,800. If you file as head of household, you can stay in the 15 percent tax bracket up to $49,400 for a single income. Meanwhile, the 15 percent tax bracket for single filers is capped at just $36,900. Go above these incomes and you'll find yourself in the 25 percent tax rate bracket. It pays to stay in the 15 percent category as long as you can [source: Pomerleau].
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 $1,000 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 $75,000 typically won't qualify [source: Tax Credits for Working Families].
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].
More Tax Tips for Separated Couples
5: Itemize Legal Fees
A legal separation or pending divorce can rack up legal fees and court costs — neither of which are eligible for a tax deduction. So why bring these expenses up for discussion? Turns out, under certain circumstances you can reap a tax deduction benefit by claiming some legal fees and court costs that occur because of your separation.
While you can't write off the cost of your divorce, you may be able to deduct a few legal fees. The legal fees you can deduct include those related to tax advice or alimony, two topics that can have far-reaching consequences should you move forward without counsel.
It's important to ask for tax advice as you ponder the very real possibility that you may soon be paying or receiving alimony. Plus, a separation or divorce has significant repercussions on all types of taxes, ranging from income tax to property tax, and your legal counsel can help you navigate the waters. Just be sure to get an itemized billing statement from your legal counsel so you can identify the reason for each charge [source: Wood].
4: Track Medical Bills and Expenses
If you've separated, but have children together, be sure to track their medical expenses — even if you are not the custodial parent who can claim them as dependents. You may still be able to deduct your children's medical expenses from your federal income taxes, as long as you are the one who is footing the bill.
A U.S. Department of Agriculture study of parental expenditures on children found that parents whose before-tax income ranged from $61,500 to $106,500 spent about $1,000 each year in out-of-pocket medical costs per child. As any parent who has paid for orthodontia knows, expenses not often covered by insurance can really add up in a hurry [source: USDA].
If you are paying for all or a portion of your child's medical expenses, you can include them in your itemized medical expense deductions. There is a lengthy list of qualified medical expenses, so you'll want to consult with a tax professional or peruse IRS information. Some of the most applicable include dental treatment, eyeglasses, insurance premiums (including health, life, dismemberment and more) and prescription drugs [source: IRS].
3: Understand Innocent Spouse Relief
Did your estranged spouse underpay taxes or lie about assets on your last joint return? We're not saying it happened, but we're suggesting you should be prepared if the possibility exists. Otherwise, you may end up being equally liable for your partner's mistakes.
The best way to cover your assets is by understanding how Innocent Spouse Relief works. If you filed a joint return with a spouse who falsified income, and then you signed the return without suspecting any wrongdoing, you may qualify for Innocent Spouse Relief. This means you won't be held liable for unpaid taxes or anything else that may have been misrepresented.
There are other, more nuanced forms of Innocent Spouse Relief that could offer protection, even if you don't meet the traditional criteria. If you've been living apart from your spouse for a year before filing an Innocent Spouse Relief request, or if you are widowed, you may still qualify. There are additional protections for spouses who were under threat of domestic violence at the time the taxes were filed, too [source: IRS].
2: Don't Deduct Child Support
Child support is the term used for court-ordered payments to support a child or children age 18 or younger. When you have children and become legally separated, child support usually factors into the arrangement. If you are not legally separated, but informally estranged, you are not required to pay child support, although some parents opt to make voluntary payments. Although these voluntary payments won't count toward any future court-ordered child support payments, be sure to record the financial contributions you make.
Whatever the arrangement, money paid for child support is not tax deductible. For example, if Sarah pays $300 a month in child support during her separation from Ben, it is not an expense she can deduct from her income taxes. And, if she falls behind on child support payments, her tax refund could be garnished for child support.
On the other hand, Ben, who is receiving child support, does not have to claim the money as income. Because child support can't be claimed as income, it's not subject to taxation, either [source: Wall-Cyb].
1: Beware Capital Gains
There's only one home and there are two of you. Clearly, you can't both lay claim to the place if you're heading toward divorce, so why not sell it? For many couples, it's a solution worth exploring. There are, however, some tax traps ready to snap once the "sold" sign goes up in the front yard. Namely, the capital gains tax.
Capital gains tax is profit from the sale of a home. To figure the amount of capital gain, sale expenses, home improvements and the original purchase price are deducted from the sale proceeds. Anything left over is considered capital gain.
There is good news, though. While you are separated, but still married and planning to file joint taxes, you can potentially exclude up to $500,000 of capital gains if you've occupied it as a primary residence for two of the past five years. If you are filing separately, the amount becomes $250,000 per person. The $250,000 per person threshold stands if you receive the home in the divorce settlement and sell it at a later date.
If, for example, you purchased your home two years ago and are now selling it during your separation from your spouse, you will still reap some of the benefits of capital gains tax exclusion. The amount will depend on your particular circumstances, so be sure to contact a tax professional [source: Kearson].
The most sweeping tax overhaul in decades became law in December 2017. HowStuffWorks explains what taxpayers can do to benefit from the tax changes.
Author's Note: 10 Income Tax Tips for Separated Couples
Taxes can be complicated. After all, the tax code changes every year and, frequently, so do our circumstances. When it comes to spousal separation and division of assets, it's important to know how seemingly simple decisions affect your finances.
- Cussen, Mark. "Divorcing? The Right Way to Split Retirement Funds." Investopedia. (Nov. 5, 2014) http://www.investopedia.com/articles/retirement/03/060403.asp
- IRS. "Alimony Paid." Aug. 18, 2014. (Nov. 4, 2014) http://www.irs.gov/taxtopics/tc452.html
- IRS. "Don't Overlook the Child and Dependent Care Tax Credit." March 20, 2014. (Nov. 4, 2014) http://www.irs.gov/uac/Newsroom/Dont-Overlook-the-Child-and-Dependent-Care-Tax-Credit
- IRS. "Innocent Spouse Relief." Oct. 15, 2014. (Nov. 5, 2014) http://www.irs.gov/Individuals/Innocent-Spouse-Relief
- IRS. "Medical and Dental Expenses." Aug. 19, 2014. (Nov. 5, 2014) http://www.irs.gov/taxtopics/tc502.html
- Kearson, Nancy. "How Will a Divorce Affect Capital Gain Taxes on Selling of Properties." (Nov. 5, 2014) http://www.calcpa.org/content/consumers/ask/2003/06.01.aspx
- Pomerleau, Kyle. "The 2014 Tax Brackets." Nov. 27, 2013. (Nov. 5, 2014) http://taxfoundation.org/article/2014-tax-brackets
- Tax Credits for Working Families. "Child Tax Credit." (Nov. 5, 2014) http://www.taxcreditsforworkingfamilies.org/child-tax-credit/
- USDA. "Expenditures on Children by Families." 2013. (Nov. 5, 2014) http://www.cnpp.usda.gov/sites/default/files/expenditures_on_children_by_families/crc2013.pdf
- Wall-Cyb, Teresa. "Alimony, Child Support and Taxes." Divorce Net. (Nov. 4, 2014) http://www.divorcenet.com/resources/divorce/divorce-taxation/child-support-alimony.htm
- Wood, Robert. "The Only Good Legal Fees Are Tax Deductible Legal Fees." Forbes. Sept. 22, 2010. (Nov. 5, 2014) http://www.forbes.com/sites/robertwood/2010/09/22/the-only-good-legal-fees-are-tax-deductible-legal-fees/