|
Divorce is a very serious subject. It's the end of a marriage; the parting of one into two, and it can be fraught with stress and emotional turmoil. Divorce is also a minefield of tax issues that can cripple the departing parties economically if poorly navigated. The reason for these dangers is buried in the history of the tax code's development. In the earliest days of income tax each individual was taxed the same way, regardless of his or her marital situation or dependents. However, congress later added different tax rates for married individuals to alleviate the burden on single income families. While this also imposed a potential burden on two income families, at the time it was enacted single income families made up a much higher percentage of married couples than they do today. Unfortunately, in order to maintain equity the same primarily beneficial tax rules for married couples also must to be applied to divorcing couples. The result is the process of division of assets, timing of the finalization of the divorce, divorce expenses, and alimony payments create a pockmarked economic mine field for divorcing couples.
The first in a series of articles intended to help divorcing couples explore the complex minefield of divorce tax issues, this article will primarily tackle the complex issue of timing the finalization of a divorce to create the least tax burden on both parties. Future articles will tackle legal expenses, property distributions, innocent/injured spouse status, dependent exemptions before and after divorce, and alimony payments.
One of the first issues most divorcing couples encounter is when to make the divorce final. The rule of law for divorce mirrors that of marriage, a couple is deemed divorced for the entire year if they were divorced at any time during the year, as provided under IRC 7703(a). The greatest factor in determining the best timing is the economic situation of both spouses and the disparity between the married filing joint and single tax rate thresholds. Exempting the complication of alimony, which effectively transfers one spouse's taxable income to the other (and will be covered later), if one spouse earns significantly more than the other, it may be in their best interest to defer finalizing the divorce until the following January because of the effectively lower tax rates. If both spouses earn similar incomes, particularly if their combined income places them in greater than the 25% bracket (one of the recent tax acts increased the lower tax bracket thresholds for married filing joint filers to equal twice the single thresholds for the same tax brackets in an effort to elevate the marriage penalty for low and middle income couples), it may be in their best interest to advance the date the divorce is finalized to allow both spouses to optimize their tax savings by counting as single throughout the year.
These timing strategies help to minimize the effect of taxes during the year of divorce. It can save several thousands of dollars for division in the ultimate property settlement or the party that sees the greatest benefit can simply come to an agreement to reimburse the other party for any tax burden they might suffer as a result of the choice. Timing strategies are best suited to couples involved in amicable divorces. Couples involved in inamicable divorces are likely filing as married filing separate, and their tax situation is usually best served by moving the final date of divorce up as much as possible to allow them the highly preferential rates single filers have in comparison to married filing separate filers. It should be noted the government has already seen the potential abuse of the marriage timing rules in section 7703 and has taken steps to subvert the potential. A couple that lives together the entire year as a married couple, divorce in December and remarries in January, is deemed married for the entire year.
Couples unfortunate enough to be parting on less than amicable terms may have the added issue of mistrust and economic responsibility for their spouse's tax burden if they aren't careful. These individuals may be best served by severing themselves completely from their spouse's economic situation by filing their tax return under the married filing separate status. While this status has arguably the highest tax burden, with rate thresholds half that of married filing joint status, half the available standard deduction, and many tax options and credits banned, it serves to successfully sever one spouse's tax burden from the other. These onerous rates can also provide a tax incentive for both spouses to move the divorce proceedings along if both have substantial income.
As in all cases, each situation is different and needs to be analyzed thoroughly with all the possible options to determine the least burdensome tax effect. Timing the finalization of a divorce is only one of many factors affecting each divorcee's tax burden and competent tax advice under these circumstances can be as valuable as competent legal advice.
|
|
