Isn’t it amazing how long it seems to take for summer vacation to get here, but don’t you get the feeling in March that you barely finished last year’s taxes and here it is again already? Doesn’t seem right! Here are some fundamentals that deal with divorce and taxes you likely already know, but let’s go through them briefly:
- Income includes more than just your paycheck. It’s an inescapable fact of life that, if you make money, sooner or later you are going to have to share it with the federal government. How does that happen? Somebody who paid you money sends you a W-2, a 1099, a K-1, or one of about a hundred other little forms which proclaim you have received taxable income from that person or entity. And here’s the catch: the IRS plays us all against one another by forcing the employer, the bank, the broker, the casino in Las Vegas or whoever paid you the money to send them a copy of that exact, same form. Otherwise, the government won’t let them deduct the payment to you as a tax-deductible expense against their income. It won’t do any good for you to burn your house down with the 1099 in a drawer somewhere in your house, because the IRS already has its own copy. The best thing to do is just sit back and reflect on how much fun it was to get a tip from the gambling god recommending you buy a $2 exacta box ticket in wild speculation that horses 3 and 11 will run first and second in the upcoming race at Belmont and …. sure enough they did! Do that while you are on hold to speak with your CPA about a better tactic on how to handle the tax consequences of that unexpected burst of income. It won’t come quickly, either, so ignoring it will just amp up your tax bill with interest and penalties.
- Figure out your filing status. Do your best to make an agreement with your spouse (and stick the terms of that agreement into your divorce decree) about how the two of you will handle your tax returns for the year of divorce. Your status as married or divorced is determined by your status on December 31 of the applicable year. The divorce judge can’t order either of you to address it in a certain way, but you and your spouse can agree to file a certain way and write it into your divorce decree.
- Filing single status. Let’s say you got divorced in late December 2014 – even as late as December 31, 2014 – without agreeing to terms on taxes. Now it’s mid-March 2015 and you are wondering what to do with April 15th looming. Your filing status is single, since you were divorced in 2014. That means you must report 100% of your income and can claim 100% of your withholding (absent any written agreement to the contrary). You are entitled to claim your personal exemption, but not the exemption for your spouse. If you are not the primary custodian of your minor children, your spouse will have the presumptive right to claim the exemptions. If you and your spouse owned a residence on which you paid mortgage interest and ad valorem taxes, you may or may not be able to claim those tax deductions, as no presumptions apply. Because Texas is a community property state, even if you were the sole earner in your household, those earnings would have been community property belonging to the two of you up through the date of divorce. You can settle all these matters as a part of your divorce, by reaching agreement with your spouse on taxes for the year of divorce, and including the terms of that agreement in your divorce decree.
- Married filing separately status. Let’s reverse the dates and say you got divorced on January 2, 2015, or thereafter, without agreeing to terms on taxes. Now, the IRS regulations require you to report yourself as married for filing status purposes for tax year 2014. That will likewise apply to your spouse. Strictly following the regulations, the IRS requires that each of you file as married filing separately, reporting one-half of all income, estimated tax payments, withholding tax payments, and half of all deductions applicable to each of you. That means your spouse reports half of your income but also claims half of your withholding and other tax payments and half of all your allowed deductions. You must likewise report half of your spouse’s income, and can claim half of your spouse’s withholding and other tax payments and half of all his or her allowable deductions. You would be responsible for any taxes due based on your return, and would be entitled to any overpayment of taxes shown on your return. Likewise for your spouse. Keep in mind that married, filing separately results in a higher tax rate than filing as a single person or married, filing jointly, and that you may not be getting correct information from your spouse.
- What should you do? You should consult with a licensed, competent CPA. Your objective is to file the most correct return you can, yielding you the lowest amount of tax to pay, and avoiding any liability for taxes on your spouse’s income (in case your spouse does not file correctly). You should make sure that your spouse understands the consequences of filing an incorrect return. If, for instance, both of you claim any of the same tax deductions or exemptions the IRS computers will eventually discover that discrepancy and pump out letters to both of you demanding explanations for what caused that result and payment for the shortfall amount of taxes which were not paid, along with interest and penalties on the unpaid amount. At that point, the IRS will decide for itself who should pay all that, and it may be you.
- What can you do? The tax code provides many options for divorcing couples to make contractual agreements on tax reporting matters. State courts have no power to make orders on federal matters, but the parties in interest – you and your spouse – can make a contract which the government will recognize and which the state courts will enforce if either party breaches the contract. You and your spouse can partition your respective incomes, deductions, tax credits, and exemptions pertaining to children for tax reporting purposes. It should be a key objective of yours to make such agreements and put them into your divorce decree as a contract, rather than as a court order. If you can’t agree on this before you get divorced, you are not likely to be able to agree on it later.