Hear From Our Experts - Tax - Ed Schenkein

Tax Credits and Other Opportunities in Marital Dissolution
By W. Edward Schenkein, CPA/CVA/CFE

We have previously outlined some of the tax and economic issues that may arise in your marital dissolution. We addressed such issues as:

• Determining what assets you own and what they are worth,
• The protection granted under the Innocent Spouse Rule, and
• Taking the exemption for the child(ren) and the tax treatment of support payments.

The Internal Revenue Code is complex, ever-changing, and does not provide simple answers for parties to a divorce. Here are a few matters for you to consider as you make your way through the tax and economic effects of your divorce.

Child Support Payments
A divorce or separation agreement typically provides for a specified amount of alimony and a specified amount of child support. If the spouse paying the support pays less than the amount designated for child support, then the entire payment may be treated as child support and no part treated as alimony.

Costs of Getting a Divorce
You cannot deduct legal fees and court costs for getting a divorce. However, you may be able to deduct legal fees paid for tax advice in connection with both the divorce and the set-up of support payments. In addition, you may be able to deduct fees you pay to appraisers, actuaries, and accountants for services in determining your correct tax or in helping to get alimony.

Filing Status
Your filing status generally depends on whether you are single or married. In some cases, it depends on other factors as well. Whether you are single or married is determined as of the last day of your tax year, which is December 31 for most taxpayers.

Marital Status
In general, your filing status depends on whether you are considered unmarried or married. For tax status purposes, a marriage is narrowly defined as a legal union between a man and a woman as husband and wife.

However, a special rule (see head of household below) permits you to be treated as unmarried for purposes of filing status if:

• You do not file a joint return for the year;
• Your home is a household which is the principal residence of a child for more than half the year;
• You furnish more than half of the cost of maintenance for that household; and
• During the last six months of the year, your spouse is not a member of that household.

Unmarried Persons: You are considered unmarried for the whole year if, on the last day of your tax year, you are unmarried or legally separated from your spouse under a divorce or a separate maintenance decree. State law governs whether you are married or legally separated under a divorce or separate maintenance decree.

Divorced Persons: If you are divorced under a final decree by the last day of the year, you are considered unmarried for the whole year.

Divorce and Remarriage: If you obtain a divorce in one year for the sole purpose of filing tax returns as unmarried individuals, and at the time of divorce you intended to and did remarry each other in the next tax year, you and your spouse must file as married individuals.

Head of Household
If you are unmarried you may qualify to file as a head of household. Filing as head of household has the following advantages.

1. You can claim the standard deduction even if your spouse files a separate return and itemizes deductions.
2. Your standard deduction is higher than is allowed for a single or married filing separate return.
3. Your tax rate may be lower than it is on a single or married filing separate return.
4. You may be able to claim certain credits (such as child care credit and earned income credit) not claimable on a married filing separate return.
5. Your income limits that reduce the child tax credit, itemized deductions, and the amount you can claim for exemptions will be higher than the limits on a single or a married filing separate return.

Requirements. You can file as head of household only if you were unmarried or considered unmarried on the last day of the year. You also must have paid more than half the cost of keeping up a home that was the main home for more than half the year (except for temporary absences, such as for school) for you and any of the following qualifying persons.

Divorced Taxpayers
If you are divorced, you are still jointly and individually liable for any tax, interest and penalties due on a joint return for a tax year ending before your divorce. This responsibility applies even if your divorce decree states that your former spouse will be responsible for any amounts due on previously filed joint returns. There are various types of relief available from such liability for which you may or may not qualify. For example, you may elect to limit your liability for joint returns you have already filed to the portion of the tax deficiency that is allocable to you.

Tax Credits
You may be entitled to a number of tax credits. These include the following.

• Earned income credit - a refundable Federal income tax credit for low-income working individuals and families.
• Child and dependent care credit (see below).
• Child tax credit – Note that the new tax legislation eventually increases the credit to $1,000 in 2010 for each qualifying child under age 17. Subject to certain income limits, the child credit may be refundable.

Please note that the combined total of the credits taken may be limited.

Child and Dependent Care Credit
If you paid someone to care for your child or other qualifying individual while you were working or looking for work, you may be able to receive a non-refundable tax credit up to 30% of qualified expenses, restricted to those taxpayers with adjusted gross income of $10,000 or less.

If you were divorced, legally separated, or lived apart from your spouse during the last six months of the year, you may be able to take the credit or exclusion even if your child was not your dependent.

Now what?
Talk to your attorney and your CPA. Have them assist you in determining your options for the various issues. Prioritize the items both for yourself and your ex-spouse. Look at what is necessary and negotiable. Consider the short-term and long-term impact of these choices. Since the actual out-of-pocket dollars are always greater than the tax effect, do not allow the tax effects alone to sway you one direction or another.

Ed Schenkein is a partner at Stark Winter Schenkein & Co., LLP, a Denver CPA firm specializing in audit, tax and consulting services.