Divorce can affect your income taxes. Your written settlement agreement should state how you and your spouse will handle:
- Dependency exemptions
- Filing status/final joint tax return
- Location of income from joint bank and brokerage accounts
Dependency exemptions can sometimes be used to benefit both spouses.
Generally, the settlement agreement will state who is entitled to claim which of the children, as well as various conditions under which this will change. But the agreement only determines what you and your spouse have decided about who is entitled to the exemption. Under the Internal Revenue Code section 152(e), the exemption belongs to the custodial parent unless the custodial parent executes a release. That release must be signed by the custodial parent and attached to the non-custodial parent’s return for any year in which the non-custodial parent claims an exemption deduction. The release can cover a single year, specific multiple years, or all future years.
The IRS form for the release is Form 8332.
Filing Status and Final Return
Filing Status – Barring remarriage, a non-custodial parent generally will be “single” and a custodial parent may be “head of household.” A planning idea that can be a win-win in joint custody cases where there is more than one child involved, though, is to have each parent be a “custodial parent” with respect to at least one child. In that way, both parents may qualify for “head of household” status. “Head of household” tax rates are more beneficial that the “single” rate chart.
Final Return – Unless the process of divorce begins and ends within a single calendar year, the final return on returns can be an issue. You and your spouse can execute an agreement on how to share any savings from filing a joint return.
A taxpayer’s marital status is determined as of December 31. Generally the choice is between “married filing separately” and a joint return. If the couple have been living apart for the last six months of the year, it is possible that one might qualify as “head of household.”
The decision to file a joint return can have an impact beyond the tax difference between a joint return and two separate returns. Taxpayers have “joint and several liabilities for deficiencies” on a joint return. This means that you are responsible as a couple and that you are responsible individually for errors on your joint tax return. You may be liable for any deficiencies that the Internal Revenue Service finds in your joint return. If you are concerned that the other spouse might have unreported income or be claiming improper deductions, it may be wise to forgo any joint tax return savings.
If you decide to file a joint return, you cannot change your mind and file a separate return later. But if you file a separate return, it is possible to file an amended joint return later. Here is a suggestion for how to approach the situation if you and your spouse could get substantial savings from a joint return, but you are concerned about being saddled with the other spouse’s deficiency. You and your spouse can file separate returns. If you later learn that the other spouse’s return had no deficiencies, you and your spouse can file an amended joint return prior to the expiration of the statute of limitations, (generally, three years from the date the original return was filed, or two years from the time the tax was paid, whichever is later).
Special Note: If your spouse has (in the past) hidden taxable income from the IRS and you signed a joint tax return for those years, you may be responsible for past due taxes if s/he is caught. The IRS has a special “innocent spouse tax relief” provision that can help if you have been held responsible.
Allocation of income from joint bank and brokerage accounts
If you don’t file a joint return, a number of complications may arise. If you and your spouse had planned to pay your tax bill by having the taxes withheld through each of your W-2’s, then there is no way to shift the withholdings to another return. If you and your spouse made joint estimated tax payments, they may be divided in whatever way you and your spouse agree. If there is no agreement between you, the IRS will divide them based on relative tax liability.
If it becomes clear before all estimated tax payments are made that you and your spouse may file separate returns, then the person making the payments should submit them as individual estimated tax payments.
In addition, if you don’t file a joint tax return, you and your spouse should decide who is to report joint income and which of the parties will claim joint deductions. This may seem to be a simple matter but sometimes it is not.
For example, look at the situation where one spouse has left the marital home, but has continued to pay the mortgage. Either side may claim for the interest deduction since the house is in joint names. This is also true for charitable donations paid from the joint checking account when the two of you were living together. These areas can be further complicated when both spouses have income. The income may have been commingled during the year and used to pay “joint” expenses. There may be additional complications when one spouse’s income is significantly greater than the other’s. This may provide “proof” that the spouse with the higher income paid more of the joint expenses.