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Taxpayers are frequently blindsided when their filing status changes because of a life event such as marriage, divorce, separation, or the death of a spouse. These occasions can be stressful or ecstatic; the last thing most people will be thinking about is the tax ramifications. But the ramifications are real and must be considered to avoid unpleasant surprises. The following are some of the significant tax complications for each situation.
Separated – Separating from a spouse is probably the most complicated life event and is undoubtedly stressful for the family involved. A separated couple can file jointly for taxes because they are still married or file separately.
Filing Status – If the couple has lived apart from each other for the last six months of the year, either or both of them can file as head of household (HH) provided that the spouse(s) claiming HH status paid over half the cost of maintaining a household for a dependent child, stepchild or foster child. A spouse not qualifying for HH status must file separately as a married person if the couple chooses not to file a joint return. The married filing separate status is subject to a host of restrictions to keep married couples from filing separately to take unintended advantage of the tax laws. A joint return usually results in less tax than two returns filed as married separately. However, when married taxpayers file joint returns, both spouses are responsible for the tax on that return (referred to as joint and several liability). This means one spouse may be liable for all the tax due on a return, even if the other spouse earned all the income. This holds even if the couple later divorces, so when deciding whether to file a joint return or separate returns, taxpayers who are separated and possibly on the path to a divorce should consider the risk of potential future tax liability on any joint returns they file.
Children – Who claims children can be contentious between separated spouses? If they cannot agree, the one with custody for most of the year can claim the child as a dependent along with all associated tax benefits. When determining who had custody for the more substantial portion of the year, the IRS goes by the number of nights the child spent at each parent’s home and ignores the hours spent there in a day.
Alimony – Alimony is the term for payments made by one spouse to the other spouse for the support of the latter spouse. Under tax law before tax reform, the alimony recipient includes it as income, and the payer deducts it as an above-the-line expense on their returns. The tax reform rule is that alimony is non-taxable to the recipient if received from divorce agreements entered into after December 31, 2018, or pre-existing agreements modified after that date to treat alimony as non-taxable. Therefore, post-2018 agreement alimony cannot be treated by the recipient as earned income for purposes of an IRA contribution and can’t be deducted by the payer. Payment for the support of children is not alimony. To be treated as alimony by separated spouses, the payments must be designated and required in a written separation agreement. Voluntary payments do not count as alimony.
Community Property – Nine U.S. states – Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin – are community property states. Generally, community income must be split 50–50 between spouses according to their resident state’s community property law. This often complicates the allocation of income between spouses, and they generally cannot file based on just their income.
Divorced – Once a couple is legally divorced, tax issues become clearer because each former spouse will file based on their income and the terms of the divorce decree related to spousal support, custody of children, and division of property.
Filing Status – An individual’s marital status as of the last day of the year is used to determine the filing status for that year. So, if a couple is divorced during the year, they can no longer file together on a joint return for that year or future years. They must, unless remarried, either file as single or head of household (HH). To file as HH, an unmarried individual must have paid over half the cost of maintaining a family for a dependent child or dependent relative who also lived in the home for more than half the year (exception: a dependent parent need not live in their child’s house for the child to qualify for HH status). If both ex-spouses meet the requirements, then both can file as head of household.
Children – Normally, the divorce agreement will specify which parent is the custodial parent. Tax law specifies that the custodial parent is entitled to claim the child’s dependency and associated tax benefits unless the parent releases the dependence to the other parent in writing. The IRS provides Form 8332 for this purpose. The release can be made for one year or multiple years and can be revoked, with the revocation becoming effective in the tax year after the year the cancellation is made. Family courts often award joint custody to the parents. If the parents cannot agree on which will claim a child as a tax dependent, then the IRS’s tie-breaker rule will apply. This rule specifies that the one with custody for most of the year, measured by the number of nights spent in each parent’s home, is entitled to claim the child as a dependent. The parent claiming the dependency can also take advantage of other tax benefits, such as childcare and higher education tuition credits.
Alimony –See alimony under “separated.”
Recently Married – When a couple marries, their incomes and deductions are combined, and they must file as married individuals.
Filing Status – If a couple is married on the last day of the year, they can either file a joint return combining their incomes, deductions, and credits or file as married separately. Generally, filing jointly will provide the best overall tax outcome. But there may be extenuating circumstances requiring them to file as married separately. As mentioned earlier, married filing separate status is riddled with restrictions to keep married couples from taking undue advantage of the tax laws by filing individual returns—best look before you leap.
Combining Income – The tax laws include numerous provisions to restrict or limit tax benefits to higher-income taxpayers. The couple’s combined incomes may be enough to encounter some of the higher income restrictions, with unpleasant tax results.
Affordable Care Act – If one or both spouses acquired their health insurance through a government marketplace and received a premium supplement, their combined incomes may exceed the eligibility level to qualify for the supplement, which may have to be repaid.
Widowed – When one spouse of a married couple passes away, a joint return is still allowed for the year of the spouse’s death. Furthermore, the widow or widower continues to use the combined tax rates for up to two additional years, provided the surviving spouse hasn’t remarried and has a dependent child living at home. This provides some relief for the survivor, who would otherwise be straddled with an unexpected tax increase while also facing the potential loss of some income, such as the deceased spouse’s pension and Social Security benefits.
If any of these situations are relevant to you or a family member, please call for additional details that may apply to your circumstances.