The Tax Effects of a Divorce
Alimony
Alimony is deductible by the payer and considered taxable income for the payee. It’s important for both the payer and recipient to have alimony payments clearly defined in the divorce agreement. As the payer of alimony, you don’t have to itemize to claim it as a deduction. It’s considered an “above the line” deduction. If you are the receiver, you can avoid a big tax bill at the end of the year if you pay estimated taxes as you receive payments.
A payment to a spouse under a divorce or separation agreement executed after 1984 is treated as alimony if it meets the following requirements:
- The payment is in cash.
- The instrument does not designate the payment as not alimony.
- The spouses don’t file a joint return.
- The spouses are not members of the same household at the time the payments are made. This requirement applies only if the spouses are legally separated under a decree of divorce or separate maintenance.
- There is no liability to make any payment (in cash or property) after the death of the recipient spouse.
- The payment is not treated as child support.
Children
Child support is not deductible by the payer, and it does not have to be claimed by the recipient. Your decree should include a definitive ending period for child support not related to the age or any life changes of your children.
A special rule applies for determining who gets the exemption for a child in the case of a divorce or legal separation. If you’re the custodial parent, you can claim the child as a dependent. However, the noncustodial parent can claim the Dependent Exemption (and the Child Tax Credit) for the child with the consent of the custodial parent. The custodial parent can “release” the child for this purpose using Form 8332.
The custodial parent may still qualify as Head of Household, and may be eligible for the Child Care Credit, Exclusion for Child Care Benefits and Earned Income Credit for that child. The noncustodial parent can’t claim these benefits even though that parent can claim the exemption.
Custody should be spelled out clearly in the decree. If there’s any confusion, the IRS may have cause to disaffirm the claiming rights of either parent.
Head of Household Status
Several factors will determine if you’re eligible to file as Head of Household:
- You have to be either unmarried or considered unmarried (see below) on the last day of the year.
- A qualifying person must have lived in your home for more than half the year.
- You must have paid more than half the cost of keeping up your home for the year.
If a person is your qualifying child, that child is a qualifying person even if you can’t claim the exemption for that child. But if the child is married, the child is not a qualifying person unless you can claim an exemption for the child. Any other person is a qualifying person only if you can claim the exemption for that person. See IRS Publication 501 for more detail about the rules for a person who is not your qualifying child.
To be considered unmarried, you must file a separate tax return; you and your spouse must not have lived together during the last 6 months of the tax year; you must have paid more than half the cost of keeping up your home for the year; your home must have been the main home of your child, stepchild or eligible foster child for more than half the year; and you must be able to claim an exemption for the child.
IRAs and Employer-provided Retirement Plans
Your Qualified Domestic Relations Order (QDRO) will address how the divorce affects your IRAs and employer-provided retirement plans.
A QDRO is a decree, judgment or court order that relates to benefits paid to your child, spouse, former spouse or dependent. To be considered a QDRO, a document must meet specific requirements. Failure to meet these requirements can result in unintended tax consequences. See IRS Publications 504 and 575 for more information about QDROs.
Disaster Tax Relief
The IRS announces special tax relief for victims of recent hurricanes, floods, earthquakes, tornadoes, droughts and wildfires.
If you are in the covered disaster areas of a recent natural disaster, you may qualify to receive an extension on your tax deadlines. Affected taxpayers include those living in the disaster areas, those outside the disaster areas whose tax records are located in the areas, businesses located in the disaster area and relief workers.
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Disaster
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Relief
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Nevada: Severe flooding Jan. 5, 2008Covered disaster area: Clallam, Grays Harbor, King, Kitsap, Lewis, Mason, Pacific, Snohomish, Thurston and Wakhiakum counties
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Deadlines to file and pay taxes and perform other time-sensitive acts falling on or after Jan. 5, 2008, and on or before March 5, 2008, are postponed to March 5, 2008.Penalty for failure to deposit employment and excise taxes due on or after Jan. 5, 2008, and on or before Jan. 22, 2008, are waived as long as taxes were deposited by Jan. 22, 2008.
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Indiana: Severe winter storms and flooding Jan. 5, 2008Covered disaster area: Carroll, Cass, Elkhart, Fulton, Jasper, Marshall, Pulaski, Tippecanoe and White counties
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Deadlines to file and pay taxes and perform other time-sensitive acts falling on or after Jan. 7, 2008, and on or before March 31, 2008, are postponed to March 31, 2008.Penalty for failure to deposit employment and excise taxes due on or after Jan. 7, 2008, and on or before Jan. 22, 2008, are waived as long as taxes were deposited by Jan. 22, 2008.
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- Casualty loss reminder — Affected taxpayers may claim a disaster-related casualty loss on their current-year returns or on amended returns for the prior year. Property losses not covered by insurance can be deducted, minus a $100 deductible and 10% of your adjusted gross income. As a reminder, returns including such deductions should have the appropriate disaster noted in red ink at the top. See IRS Publication 547 for details.
- The IRS will waive fees and expedite requests for copies of previously-filed tax returns (Form 4506).
Tax Help – Armed Services
If you’re a member of the U.S. Armed Forces who serves in a combat zone, you can exclude certain pay from your income. You also have additional time to make a qualified contribution to an IRA. A combat zone is an area designated by the U.S. President by Executive Order as an area in which U.S. Armed Forces are engaging in or have engaged in combat.
Income
The following income received during service in a combat zone doesn’t have to be reported as gross income:
- active duty pay earned in any month served in a combat zone
- imminent danger/hostile fire pay during a month served in a combat zone
- re-enlistment bonus if re-enlistment or voluntary extension occurs during a month served in a combat zone
- Pay for accrued leave — the department of defense must determine the unused leave was earned during the month served in a combat zone
- pay for duties as a member of the Armed Forces in clubs, messes, post and station theaters, and other non-appropriated fund activities earned during a month served in a combat zone
- awards or achievement pay made for a suggestion or achievement made in a month served in a combat zone
- Student loan repayments if the entire year of service required to earn the repayment was performed in a combat zone
If you’re a commissioned officer (other than a commissioned warrant officer), the combat pay exclusion for any month is limited to the highest rate on enlisted pay (plus hostile fire/imminent danger pay, if any).
You do not claim an exclusion for combat pay on your tax return. The excludable amount should not be included in your Box 1 wages on Form W-2. If an excludable amount is included in your Box 1 wages, you should get a corrected Form W-2.
If you served in a combat zone for 1 or more days during a particular month, you’re allowed the above exclusions for that entire month. Combat zone service includes any periods you are absent from duty due to illness, wounds or leave. A person is considered to be serving in a combat zone if he or she becomes a prisoner of war or is missing in action if that status is kept for military pay purposes.
You can also exclude military pay earned while hospitalized (you don’t have to be hospitalized in the combat zone). Your hospitalization must be due to having served in a combat zone. This is true even if you’re hospitalized after combat zone service. For more information, check with a tax professional.
Combat Zone Considerations
Military service outside the combat zone is, for tax purposes, considered to be inside a combat zone if the service is in direct support of combat zone military operations and the service qualifies you for special military pay for duty subject to hostile fire or imminent danger.
But in these situations, you’re not considered to be in a combat zone:
- You’re present in a combat zone during leave from a duty station located outside the combat zone.
- You pass over or through a combat zone during a trip between 2 points which are outside a combat zone.
- You’re in a combat zone only for your personal convenience.
Hazardous Duty Areas
Members of the Armed Forces who serve outside a hazardous duty area in support of operations in a hazardous duty area are treated as serving in a combat zone only for the purpose of getting an extension. Meeting additional requirements may entitle you to full combat zone tax benefits.
S. Raines, Sr. Financial Advisor/Tax Preparer
Expiring Tax Law Provisions
Tax laws change every year, making some provisions drop off while others get extended or even become permanent. Keeping track of which tax benefits are still around come tax time can be confusing.
Check out our quick overview of expiring credits and deductions below. See which provisions have expired or are scheduled to expire. Keep in mind it’s still possible that new tax laws will be passed to bring some or all of the expired or expiring provisions back to life.
| Provision | Outcome |
| Set to Expire After Tax Year 2005 | |
| Increased AMT exemptions | Extended and increased for 2007 only |
| Nonrefundable personal credits allowed for AMT | Extended through tax year 2006 only |
| The option to deduct state and local sales taxes instead of the state income tax deduction | Extended through tax year 2007 |
| Educator’s Expense “Teacher’s” Deduction | Extended through tax year 2007 |
| Tuition and Fees Deduction | Extended through tax year 2007 |
| Work Opportunity Tax Credit and Welfare to Work Credit | The 2 credits were combined and extended through tax year 2007, eligibility for the credits will be expanded in 2007 |
| Research and Development Credit | Extended through tax year 2007 |
| 15-year straight line depreciation for restaurant property | Extended through tax year 2007 |
| DC tax incentives | Extended through tax year 2007 |
| Indian reservation tax incentives | Extended through tax year 2007 |
| Suspension of percentage depletion limitation | Extended through tax year 2007 |
| Set to Expire After Tax Year 2006 | |
| Combat pay may be used to calculate EIC | Extended through tax year 2007 |
| Retirement contributions — Saver’s Credit | Has been made permanent |
| Set to Expire After Tax Year 2007 | |
| 30% credit for residential energy-efficient property (residential solar water heating, solar electric equipment and fuel cell property) | Extended through tax year 2008 |
| Credit for contractors who build new, energy-efficient homes | Extended through tax year 2008 |
| Deduction for energy-efficient commercial buildings | Extended through tax year 2008 |
| Credit for electricity produced from certain renewable resources | Extended through tax year 2008 |
| New Markets Tax Credit | Extended through tax year 2008 and modified to allow investment in non-metropolitan counties |
| Set to Expire After Tax Year 2008 | |
| Reduced rates for capital gains and qualified dividends | Extended through 2010 |
| Increased section 179 deduction and phaseout threshold ($100,000/$400,000 for 2007) adjusted for inflation; also increased for 2008 only under the Economic Stimulus Act of 2008 ($250,000/$800,000) | Extended through 2010 |
Tax Help – Accelerated Deductions
Itemizing Deductions
Higher standard deductions — $5,350 for Single and Married Filing Separately, $7,850 for Head of Household, and $10,800 for Married Filing Jointly and Qualifying Widow(er) statuses — mean that fewer taxpayers benefit from itemizing deductions. (The standard deductions are even higher for taxpayers age 65 and older and those who are legally blind.) Itemizing generally pays off only if your qualifying expenses total more than the standard deduction for your filing status.
Bunching
When deciding whether or not to itemize deductions, your year-end strategy should focus on bunching, the practice of timing expenses to produce “lean” and “fat” years. In 1 year, you would try to amass as many deductible expenses as possible.
For example, you can time your fourth-quarter state estimated tax payment and certain medical procedures to ensure the expenses are paid when they will result in the greatest tax benefit. The goal is to surpass the standard deduction amount and claim a larger deduction.
In alternating years, you skimp on deductible expenses to hold them below the standard deduction amount because you get credit for the full standard deduction regardless of how much you actually spend. In the “lean” years, year-end plans stress pushing as many deductible expenses as possible into the following “fat” year when they’ll have some value.
Accelerating Deductions
Accelerating deductions is 1 method of trimming taxable income — and your tax bill — for the current year. Some examples:
- You can make your last state estimated tax payment in December rather than the following January.
- If your current-year medical expenses are close to or exceed 7.5% of your adjusted gross income (AGI), but are usually below the 7.5% threshold, try to schedule next year’s expenses for this year. For example, purchase glasses and prescription drugs or schedule a physical in December.
- If you’re allowed to pay your real estate tax in 2 installments — for example, December and June — consider paying the full year’s tax in December.
Note: Some of the expenses you can normally deduct (for example, taxes and expenses subject to the 2% of AGI floor) are not deductible if you’re subject to the alternative minimum tax. Accelerating those expenses may not result in tax savings.
S. Raines, Sr. Financial Advisor/Tax Preparer
Stimulus Package Ready to “Rock ‘n Roll” in May
The Internal Revenue Service today advised taxpayers that in most cases they will not have to do anything extra this year to get the economic stimulus payments beginning in May.“If you are eligible for a payment, all you have to do is file a 2007 tax return and the IRS will do the rest,” said Acting IRS Commissioner Linda Stiff.
The IRS will use information on the 2007 tax return filed by the taxpayer to determine eligibility and calculate the amount of the stimulus payments.
The IRS will begin sending taxpayers their payments in early May after the current tax season concludes. Payments to more than 130 million taxpayers will continue over several weeks during the spring and summer. A payment schedule for taxpayers will be announced in the near future.
Stimulus payments will be direct deposited for taxpayers selecting that option when filing their 2007 tax returns. Taxpayers who have already filed with direct deposit won’t need to do anything else to receive the stimulus payment. For taxpayers who haven’t filed their 2007 returns yet, the IRS reminds them that direct deposit is the fastest way to get both regular refunds and stimulus payments.
Most taxpayers just need to file a 2007 tax return as usual. No other action, extra form or call is necessary. This Web site will be the best information source for all updates and taxpayer questions.
In most cases, the payment will equal the amount of tax liability on the tax return, with a maximum amount of $600 for individuals ($1,200 for taxpayers who file a joint return).
The law also allows for payments for select taxpayers who have no tax liability, such as low-income workers or those who receive Social Security benefits or veterans’ disability compensation, pension or survivors’ benefits received from the Department of Veterans Affairs in 2007. These taxpayers will be eligible to receive a payment of $300 ($600 on a joint return) if they had at least $3,000 of qualifying income.
Qualifying income includes Social Security benefits, certain Railroad Retirement benefits, certain veterans’ benefits and earned income, such as income from wages, salaries, tips and self-employment. While these people may not be normally required to file a tax return because they do not meet the filing requirement, the IRS emphasizes they must file a 2007 return in order to receive a payment.
Recipients of Social Security, certain Railroad Retirement and certain veterans’ benefits should report their 2007 benefits on Line 14a of Form 1040A or Line 20a of Form 1040. Taxpayers who already have filed but failed to report these benefits can file an amended return by using Form 1040X. The IRS is working with the Social Security Administration and Department of Veterans Affairs to ensure that recipients are aware of this issue.
“Some people receiving Social Security and veterans’ benefits may not realize they will need to file a tax return to get the stimulus payment,” Stiff said. “To reach these people, the IRS and Treasury will work closely with the Department of Veterans Affairs, the Social Security Administration and key beneficiary groups on outreach efforts.”
Eligible taxpayers who qualify for a payment will receive an additional $300 for each child who qualifies for the child tax credit.
Payments to higher income taxpayers will be reduced by 5 percent of the amount of adjusted gross income above $75,000 for individuals and $150,000 for those filing jointly.
Taxpayers must have valid Social Security Numbers to qualify for the stimulus payment. If married filing jointly, both taxpayers must have a valid Social Security Number. And, children must have valid Social Security Numbers to be eligible as qualifying children.
Taxpayers who file their tax returns using an Individual Taxpayer Identification Number issued by the IRS or any number issued by the IRS are ineligible. Also ineligible are individuals who can be claimed as dependents on someone else’s return, or taxpayers who file Form 1040-NR, 1040-PR or 1040-SS.
To accommodate taxpayers who file tax returns later in the year, the IRS will continue sending payments until December 31, 2008. The IRS also cautions taxpayers that if they file their 2007 tax return and then move their residence that they should file a change of address card with the U.S. Postal Service.
The IRS will mail two informational notices to taxpayers advising them of the stimulus payments. However, taxpayers should be alert for tax rebate scams such as telephone calls or e-mails claiming to be from the IRS and asking for sensitive financial information. The IRS will not call or e-mail taxpayers about these payments nor will it ask for financial information. Scam e-mails and information about scam calls should be forwarded to phishing@irs.gov.
Related Items:
- FS-2008-15, Facts about the 2008 Stimulus Payments
- FS-2008-16, Stimulus Payments: Instructions for Low-Income Workers and Recipients of Social Security and Certain Veterans’ Benefits
- Tax forms and instructions
Tax Help – IRS Processing AMT Patch Returns
The Internal Revenue Service is now processing five tax forms affected by legislation involving the Alternative Minimum Tax (AMT).On Monday, IRS systems began to accept and process returns that include the five affected forms. After several days of processing, the IRS has confirmed all systems are working properly.
In late December, the IRS announced it would delay processing of several tax forms. For the vast majority of taxpayers, the filing season this year began on time. But for any taxpayer whose return included any of the five affected forms, filing opened on Feb. 11.
Taxpayers who use the five forms can now file their tax returns as normal.
The affected forms are:
- Form 8863, Education Credits
- Form 5695, Residential Energy Credits
- Schedule 2, Form 1040A, Child and Dependent Care Expenses for Form 1040A Filers;
- Form 8396, Mortgage Interest Credit
- Form 8859, District of Columbia First-Time Homebuyer Credit
Approximately 13.5 million taxpayers will use these forms this year. Altogether, the IRS expects to receive nearly 140 million individual tax return submissions this year.
The IRS has worked closely with the software industry and tax practitioners during the reprogramming process to minimize disruptions for taxpayers and the tax community.
For more information, see Alternative Minimum Tax –– How It Affects Filing Season 2008.
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