Significant changes in the financial situations of both parties are inevitable; therefore, careful planning is necessary to minimize the tax costs of these events. This article briefly explains tax implications of divorce and remarriage.
Your marital status is an important factor in determining your income and estate tax liability. Before you change your marital status, understanding how taxes fit into this area of your life will help keep your liability low.
Alimony is deductible by the spouse paying it and taxable to the spouse receiving it. The written instrument or divorce decree cannot designate that the payments are excludable from the income of the receiving spouse or nondeductible by the paying spouse. Both spouses’ tax liabilities should be considered when determining what amounts are to be paid as alimony. Property settlements are often disguised as alimony in order to try to deduct the payments, however, regulations limit the term of the payment and the fluctuation in the amount of annual payments.
Other requirements that must be met for payments to be considered alimony are:
- Payments must be in cash and must be received by or be directly for the benefit of the receiving spouse
- Alimony liability stops upon the death of the receiving spouse
- Fees paid for obtaining alimony advice and for tax advice in connection with the divorce are deductible as miscellaneous itemized deductions
- Fees paid for the divorce are not deductible.
Child support payments are not deductible by the payor spouse, nor are they income to the payee spouse. Paymentsmust be designated as child support; if they are not, then the payments that are to be reduced when the child reaches majority, graduates from high school, leaves home, etc. will be reclassified as spousal support.
The custodial parent is entitled to the dependency exemption for the children unless that parent waives that right in writing. The non-custodial parent must have a written statement from the custodial parent granting the exemption. Even if the custodial parent waives the exemption, that parent may still qualify for the earned income credit, the childcare credits, and head of household rate. To do so, the parent must maintain the home for the dependent child more than half of the year.
In the settlement and negotiation process, consider giving the dependency exemption to the spouse whom will benefit most. Exemptions are phased out for higher-income taxpayers.
Regardless of which parent gets the dependency exemption, the parent who pays the child’s medical expenses may claim the related deductions along with his or her own tax return.