Many people are unaware of the nuanced tax implications that are associated with getting a divorce. There are several potential pitfalls that you will want to avoid during the divorce process and after the divorce is completed and a judgment is entered.
Pitfall # 1 – California is a Community Property State and the IRS follows state law as it relates to income apportionment
One significant consideration is understanding how income is allocated or apportioned in community property states. In a community property state like California, if the separation occurs during the tax year, the income earned, and taxes withheld prior to separation is divided equally between you and your spouse for that portion of the year. Any earnings and taxes withheld after the date of separation are considered separate property and are reported on each party’s separate tax returns. This includes bonuses earned and paid after the end of the tax year, which may be a mix of community and separate property. It is important to understand the timing and nature of when the services were performed, and the related income was earned for accurate tax reporting.
Pitfall # 2 – Joint Passive Investment Accounts
The complexity doesn’t end there. Joint passive investment accounts pose another challenge. If the divorce is pending, but the investment accounts are still undivided, any community property income earned at the end of the tax year is split based on how the income sources are characterized, i.e. 50-50.
Pitfall # 3 – Social Security
Social security derivative benefits are another aspect often overlooked. If the marriage lasted for at least 10 years from the date of marriage to the entry of the judgment, the lower-earning spouse may be entitled to derivative benefits. This means they can receive up to 50% of the higher-earning spouse’s social security benefits. However, the calculation is not always straightforward, as the Social Security Administration considers various factors, including the individual’s own benefits if they worked prior to the divorce.
It is important to note that some couples strategically delay the finalization of their divorce judgment to reach the 10-year mark required for social security derivative benefits. This highlights the importance of careful planning and understanding the implications of decisions made during divorce proceedings.
If you are newly divorced, you must be aware of the tax issues that may be associated with your changed financial status. You should seek the advice of a tax professional and stay informed about the specific regulations. This will help you to navigate the complexities and ensure accurate and advantageous tax reporting.
Ron J. Anfuso has two offices. The main office is located at 28441 Highridge Road, Suite 110, Rolling Hills Estates, CA 90274, and the northern California office is located at 516 Golden Creek Road, Mammoth Lakes, CA 91356. Call (301) 378-6606 ext. 1 to schedule a confidential appointment.
