Mitigating Tax Liability in Divorce
Divorce can be emotional, confusing and sometimes expensive. During a divorce proceeding, any advice to save money, protect cash flow or mitigate tax liability is welcomed by a client. Fortunately, there are ways to address financial issues and mitigate taxes to help offset the existence of other new expenses. You should discuss these issues in detail with your Family Law attorney and with your tax professional, such as a CPA or Financial Planner.
Spousal Maintenance & Child Support
Pursuant to I.R.C. § 71(b)(1)(A), the qualification for spousal maintenance to be deductible is that it must be made pursuant to a “Divorce or Separation Instrument.” In James J. Faylor, T.C. memo 2013-143, the tax court held that temporary payments made in the amount of $20,000 did not qualify as spousal maintenance because the agreement was never finalized by the parties. Make sure to address this financial issue early in your case with your attorney.
Child support is defined by Minnesota Statute 518.A.26, subdivision 20. Child support calculations are based on Minnesota guidelines and are presumptive; these guidelines are followed by most Judges without deviation. The calculator defines Parent A as the higher income wage earner. Parenting time is also part of the algorithm, as well as costs for medical insurance and daycare (if applicable). In some cases, there is an upward deviation in child support based on high income by a wage earner, and if it is determined to be in the best interests of the children. A downward deviation is very uncommon, and is generally disfavored by the Court.
Dependency Exemption
Generally, the custodial parent is entitled to claim the child as a dependent, unless the custodial parent affirmatively waives this right in writing (see I.R.C. § 152(e)(2) and IRS Form 8332). Custodial parent is defined as the parent having actual custody for a greater portion of the year. See I.R.C. §152(e)(3)(A). Taxpayers are required to report the social security number for all claimed dependents. In many divorce cases, parents agree to rotate the dependency exemption by year. In some cases, it makes financial sense for one taxpayer the claim the exemption each year based on income.
Child Tax Credit
I.R.C. § 24 provides for a credit of up to $1,000 for each qualifying child under the age of 17. To claim this credit, a taxpayer must provide the social security number of each qualifying child. A phase-out exists as when a taxpayer’s adjusted gross income (AGI) reaches $110,000 (married filing joint returns) and $75,000 for taxpayers filing as individual or head of household. For married filing separately, the amount is $55,000.
The Marital Home
A seller of any age who has owned a home defined as a principal residence for at least two of the five years preceding the sale can exclude from income up to $250,000 in gain ($500,000 if on a joint return where both spouses qualify) see I.R.C. § 121(a) & (b)(1). Married taxpayers filing jointly for the tax year can exclude up to $500,000 if certain conditions are met.
Tax Consequences of the Marital Home During a Divorce
The transfer of the marital home to one spouse has no tax consequence on the transferor (see I.R.C. § 1041). The tax basis for the transferee remains the same. Any future tax burdens will fall on the transferee spouse. The transferee spouse can take advantage of the exclusions in I.R.C. § 121(a) & (b)(1) if they qualify for the exclusion.
Attorney Fees and Divorce
The general rule is that attorney fees are not deductible (see United State v. Gilmore, 372 U.S. 39 (1963). There are certain exceptions to this general rule, including fees incurred for tax planning, and for obtaining taxable income (including spousal maintenance and income from a pension plan). These fees are deductible (see I.R.C. §212(1) & (3). Fees incurred to obtain child support, or in defense of spousal maintenance, are not deductible.
Innocent Spouse Rules
The IRS Restructuring Act of 1998 enacted I.R.C. § 6015, which provides relief from joint and several liability for tax, interest and penalties that may arise from a joint return. Relief may be granted if it is inequitable to hold a spouse taxpayer liable. Partial relief is also available.
Lake Harriet Law Office, LLC – Minneapolis Divorce & Family Law
To learn more about mitigating both tax and other financial liabilities during divorce, and to discuss your case, please contact attorneys Amber C. Bretl and Randall A. Smith at Lake Harriet Law Office, LLC.
Managing Attorney: Randall A. Smith – 612.750.4843
Associate Attorney: Amber C. Bretl – 612.223.8925