Q: Tax Playa, my husband is a jerk and I want out. What are some tax consequences of divorce?
Katie, Germantown MD
A: There are lots of ins and outs to this, so we'll tackle them one at a time. This post will deal with divorce, separation, alimony, property settlements, and injured/innocent spouse rules...
For more information on these topics, please refer to IRS Publication 504, Divorced or Separated Individuals.
1. A divorce or legal separation that happens on or before the last day of the year is considered final for the whole tax year. Therefore, your marital status on the last day of the year is determinative of your filing status and personal exemptions. Click on the "filing status" link to the right for more on which is the proper filing status for you to choose.
Certain fees related to divorce are deductible as a miscellaneous itemized deduction subject to the 2% of AGI threshold rules. These include tax advice on your divorce, as well as fees to financial professionals in obtaining an alimony settlement or a property transfer.
2. Alimony is a payment by one former spouse to another under a divorce or separation agreement. Alimony is deductible to the payer as an adjustment to income (meaning they don't need to itemize their deductions). Alimony is taxable to the recipient.
Child support, property settlements, and voluntary payments are not alimony. On a marital home on which the alimony payer is making mortgage payments, he can deduct half the mortgage interest and property taxes as alimony and half as an itemized deduction (assuming the home is still jointly-owned).
Alimony must be in cash, must not be considered child support or not alimony, the parties can't live in the same household, and the payments must end on death of the recipient spouse.
3. Property settlements. There are two factors to consider here. The first is a "qualified domestic relations order." This deals with payments from qualified retirement plans and child support. Generally, benefits paid to a former spouse or child is taxable to the recipient spouse, whereas IRA transfers are tax-free.
There is no recognized gain or loss on property transfers between spouses. The basis of the property is the adjusted basis of the transferring spouse (if this transfer happened before July 19, 1984 the basis is the fair market value at the time of transfer). There is normally no gift tax implications to transferring property except in the oddest of circumstances.
4. Injured and Innocent Spouse Rules. An injured spouse is a spouse who's partner's tax refund was garnished by the IRS to pay for back taxes, child support, and debt like student loans. The non-liable spouse (injured spouse) can file to get her share of her refund from the IRS.
An innocent spouse is someone who believes a joint federal tax liability should be paid solely by her spouse. This can be true if your spouse knowingly withheld income/overstated expenses, you are divorced, or it would be unreasonable to expect you to pay.
In my experience, there are a lot of jerk husbands out there who hang their wives/ex-wives out to dry on these matters. Don't be afraid to stand up for yourselves.