Divorce Choice: Filing Jointly Versus Filing Separately
A couple married on the last day of a calendar year may file jointly even if permanently separated in anticipation of a divorce. Most middle-income divorcing couples find it advantageous to file jointly, and they can file jointly if they are married as of midnight on the last day of the tax year, Dec. 31. For example, Rufus and Rhonda separate in the spring, decide to divorce in the summer, and set to working on the property settlement in the fall, but they are still legally married on the last day of the year. Rufus and Rhonda couple may:
> file jointly (called “married filing jointly”);
> file married as separate people (called “married filing separately”); or
> under certain circumstances, file as single (when they are “deemed unmarried” or “head of household”).
Even if the divorce was finalized between Jan. 1 and April 15, they are still married when it comes to filing the previous year’s taxes. If, however, the divorce became official in December, they cannot file as married even if they were for most of the year.
A married couple is liable for taxes for the years they were married, and the IRS audits the tax returns of formerly married spouses. A former spouse is not liable for current taxes, just the taxes of the years when he or she was married. If a deficiency is found, the IRS can - and does - pursue either or both spouses for the back taxes and any penalties.
Despite their marital strife, however, most couples file jointly because it results in a lower total tax bill than any of the other options. (”Married filing separately” is the most expensive way for a couple to file). If they jointly, however, both of them are responsible for the taxes due. Each spouse is responsible for the entire debt because married couples have joint and several liabilities, which means they share the responsibility.
Other Tax Considerations
While joint or separate returns are important tax decisions that every divorcing couple makes in the last year of a marriage, divorcing couples make other tax decisions, and when they negotiate and honor their agreements in good faith, they can save themselves money and aggravation.
Wealthy couples may do an extensive analysis that considers the incomes and deductions of both spouses, the number of dependents, tax credits, applicable tax rates and contributions already paid to avoid penalties.
The I.R.S. considers spousal support — alimony — as income shifting. It is deductible to the payor and taxable to the payee. Sometimes for tax reasons, spouses decide to make the payments nondeductible to the payor and tax free to the recipient. On the other hand, child support is not deductible to the person who pays it, nor is it taxable to the person who receives it.
Couples must decide which spouse takes the dependency exemption, the child-care credit, and medical deductions for a dependent child.
In property settlements, transfers between spouses are gifts and are not taxable. However, in order to pay a settlement, sometimes couples must disturb assets in a way that creates tax consequences. For example, taxes may result when a party must withdraw funds from a restricted account, such as a pension fund. Sometimes couples do “horse trading” to reduce the impact of taxes on the settlement. For example, the sale of assets received in a settlement, such as a house, may create a capital gains liability; or when both parties make an in-kind distribution of property, such as set-off and trades; or when the parties take future income from a pension to be received later.
Couples can shelter a primary residence from capital gains of up to $500,000, but the sale of other real estate may result in taxable events.
The distribution of any ERISA-qualifed pension, profit-sharing or bonus plan may have adverse tax consequences because under the I.R.S. Code and ERISA these benefits are not assignable, and can only be transferred via a QDRO.