Income Tax Considerations in Dissolution Cases

Separated spouses often overlook the question of income taxes, but this can be a costly mistake. Planning for the preparation and filing of income tax returns while the dissolution is taking place and after it is completed is as essential as estate planning.

Liability on Joint Income Tax Returns

Each spouse is "jointly and severally" liable for any taxes that are due on a joint income tax return. This means that the I.R.S. or the Franchise Tax Board can collect all of the taxes from one spouse, even though both spouses signed the return. There are two exceptions to this rule:

Innocent Spouse

A taxpayer can request to be treated as an "innocent spouse" and avoid liability on income earned by the other spouse during the marriage, if certain criteria are met. In order to obtain innocent spouse treatment, the requesting spouse has to prove that he/she had no knowledge of the unreported income and that it would be unfair to require the requesting spouse to pay the taxes. If the requesting spouse qualifies as an innocent spouse, he/she will not be required to pay taxes on the unreported income

Separate Liability

After the marriage has been terminated by a Judgment of Dissolution of Marriage, a former spouse can request "separate liability" treatment on a joint income tax return.

Post-Separation Income

In general, the income you earn after you and your spouse have stopped living together is your own as is the tax liability associated with it. However, this applies only if you file a separate return. If you and your spouse file joint returns, you are each liable for any taxes due even if you did not live together when the income was earned.

Dependency Exemptions

A parent can claim a child as a dependent if he/she has custody of the child for more than one-half of the year. This applies regardless of which parent provides more financial assistance to the child. Often as part of a marital settlement agreement, the spouses agree that the non-custodial parent will be entitled to claim a child as a dependent for income tax purposes. In such cases, the custodial parent must sign an I.R.S. form and give it to the non-custodial parent, who then attaches the form to his/her income tax return.

Filing Status

If you are not living with your spouse but the dissolution has not been completed, there are three tax filing statuses available to you: married filing separately, head of household and joint.

The married filing separately status is assigned the lowest tax rates, so it is best to file a joint return or as head of household. If the dissolution is not final, a taxpayer can file as head of household if he/she maintains a household for a minor child for at least one-half of the year.

Deductibility of Spousal Support

Spousal support payments can be deducted by the paying spouse. On the other hand, the spouse receiving spousal support must report it as ordinary income on his/her tax returns. However, these rules do not apply if the spouses file joint income tax returns.

If you are receiving spousal support you will have to pay income taxes on it, just like any other form of income. You should consult with a certified public accountant to determine the amount of estimated income taxes you should pay during the year. If your estimated income tax payments are insufficient, you will be assessed significant penalties and interest.

Sometimes, as part of a negotiated settlement, the husband agrees to pay "family support" instead of child support (which is not tax deductible) and spousal support. Under the tax law, family support is fully deductible from the income of the paying spouse.

Tax Treatment of Community Property Divisions

In general, the division of community property in a dissolution of marriage is not a taxable event. Thus, neither party is required to report a capital gain arising out of the division of the assets between the parties. The rule that community property divisions are not taxable applies even if the transfer of assets takes place several years after the Judgment of Dissolution of Marriage is filed. In such cases, there is no tax as long as the transfer is a part of the property settlement and does not take place more than six years after the Judgment of Dissolution of Marriage is filed.

Family residences are often sold as part of the property settlement in a dissolution case. There is no capital gains tax on the sale of a principal residence up to $250,000 for a single person, $500,000 for a husband and wife who are filing a joint return. However, this rule applies only if the home has been the taxpayer's principle residence for two of the five years preceding the sale.