The first tax return filed after separating from a spouse or finalizing a divorce may come as a surprise. For some ex-spouses it might be the first tax refund in years. Others may owe more than expected. Considering the tax consequences in a high-asset divorce is important.
If both parents claim a child, it may mean an Internal Revenue Service audit. IRS tiebreaker rules come into play when a divorce decree fails to address dependency exemptions, but may not be the outcome the couple envisioned.
Who can claim the child?
Each dependency exemption on a tax return reduces the amount of your taxable income. A child tax credit is also available in certain circumstances and will directly reduce the amount of tax you owe.
A child needs to be under age 19 at year-end or under 24 and a full-time student to qualify as a dependent. For the child tax credit, the child must be under age 17, cannot provide more than half of his or her support and needs to live with you for more than half the year.
When a divorce decree fails to state who can claim the children it can cause conflict each year at tax time. General IRS rules state that the parent who has the most overnights can take the deduction. If the child lives with each parent for the same amount of time in a year, the parent with the higher adjusted gross income takes the deduction.
Often parents negotiate who claims a child. For example, parents might agree to rotate years when they claim a child. In this case the custodial parent needs to use Form 8332 to release the exemption every other year. The noncustodial parent then attaches the form to his or her tax return.
Child support and alimony
Child support payments have no tax effect. The parent who pays child support does not receive a deduction and the receiving parent pays no tax on the amount received.
In contrast, alimony is viewed as income to the person who received it. That will usually mean paying estimated tax payments. An ex-spouse who pays alimony gets to deduct the full amount that he or she pays.
A divorce property award is usually tax neutral. Consider the timing of a home sale, however. A couple can earn up to $500,000 on the sale of a principal residence before paying taxes. If you receive the home in a property award and need to sell it down the road, the individual cap is only $250,000 before you would owe capital gains.
Divorce mistakes can come back to surprise you at tax time. If you are considering a divorce, speak with an experienced family law attorney who can help you put together a strategy that will minimize the tax consequences.