In the stressful time surrounding the breakup of a marriage, it may seem like taxes are the last thing to think about. However, knowing the tax effects of your choices during a divorce by obtaining professional advice can lead to better decisions in divorce negotiations and lead to a less stressful and happier financial future. I asked Yvonne Cort, Esq., a tax partner at Capell Barnett Matalon & Schoenfeld, LLP, to provide my clients with valuable tax tips to consider at all stages of the divorce process.
1. You may be eligible for innocent spouse relief. If you and your spouse have been assessed for tax on a jointly filed tax return, you can apply to the IRS or NYS Department of Taxation and Finance to request that only your spouse be liable for the tax.
There are many factors to evaluate, including among others, whether you knew or had reason to know about the under-payment or under-statement of tax at the time the return was filed, whether you had control of the household finances during the time concerned, and whether you are currently enduring financial hardship.
The IRS and NYS may look at the terms of the divorce decree or agreement to see if one spouse has a legal obligation to pay the taxes on jointly filed returns. While such an agreement will not stop tax collection against both spouses, the statement will carry weight in the determination of relief.
2. Filing status makes a difference. A married couple has the choice of filing jointly, or filing with the status “married filing separately.” When a couple files a joint tax return, each spouse is fully liable for tax due on the return, or any additional tax assessed in an audit, regardless of which spouse generated the income. The spouse who files separately will pay tax on only their own income.
Note that while you may have signed your divorce agreement, you are not legally divorced until the judgment of divorce is granted by the court. Sometimes the judgment takes many months for a judge to sign after the papers have been filed with the court. As long as you are not divorced by the end of the calendar year, you still have the option of filing jointly. In addition, if you are legally separated, you are not divorced, and therefore, you also have the option of filing jointly. You should speak with your divorce attorney and your tax advisor before deciding whether to file jointly or separately.
After a divorce, generally your filing status will be “single,” or it may be the more tax favorable status of “head of household” if you are eligible. Head of household status can apply before the divorce is finalized for those living apart and considered unmarried according to IRS rules.
3. Know your accountant. Now that you are getting divorced, your financial goals and concerns may not be the same as your spouse. You may wish to look into retaining your own accountant, not only to prepare your tax returns but also to help you understand the potential tax impact of the division of your marital assets.
4. If you can’t afford to pay your taxes, there are options. Whether or not you qualify for innocent spouse relief, you may be eligible for other collection resolutions.
- Offer in Compromise: An IRS or NYS Offer in Compromise, based on doubt as to collectibility, is a settlement for an amount less than the total balance owed. The taxpayer must submit detailed financial information with backup documentation. The Offer in Compromise examiner will evaluate assets, income, and expenses. NYS has its own rules with additional requirements. For eligible taxpayers, an Offer in Compromise can be a tremendous relief from the stress of owing back taxes.
For joint liabilities, either spouse can request an Offer in Compromise, or the couple can submit a joint Offer. An accepted Offer in Compromise submitted on behalf of one spouse will result in a settlement only for the requesting spouse. The other spouse would continue to owe the full amount, less any payments on the Offer.
- Installment Agreement: This generally permits payment in full over time, with monthly payments. IRS and NYS will look at the balance owed and the statute of limitations on collection, and may require detailed financial documentation depending on the circumstances.
- Currently not collectible: If neither of the above options are appropriate, the IRS may place you in “currently not collectible” status and stop pursuing collection against you, until your income changes, or your temporary hardship has passed. Interest and penalties continue to accrue.
5. What if tax returns were not filed? New York State offers a voluntary disclosure program with a limited lookback period for eligible taxpayers, no assessment of penalties and no referral for criminal action. The application must be submitted and accepted before filing the NYS returns.
If you have foreign bank accounts or an inheritance from a foreign relative and you have not filed the appropriate IRS tax returns, there could be serious consequences, including significant penalties. There may be eligibility for relief through IRS programs such as the non-willful streamlined procedures.
6. Review estate and gift planning. In connection with a divorce, trusts and wills should be reviewed and may need to be re-written to make sure that assets are allocated in accordance with current circumstances. Providing for an ex-spouse may involve strategies to address potential gift tax issues. Parents of a divorced child may need to review a will or trust, as there could be unintended results from the pre-divorce paperwork.
7. Investments are not the same as cash. When stocks are transferred in a divorce, the basis does not change. The value of two brokerage accounts may appear to be the same now, but after the stocks are sold and taxes paid, the net amount received could be drastically different. Find out the tax-impacted figures before deciding how to allocate accounts.
8. Retirement assets generally require detailed tax strategy. Retirement funds can be a significant portion of the marital estate, and you need to be aware of the risks and rules, and the tax strategies regarding dividing these assets. For example, a Roth IRA and traditional IRA are not equivalent. No income tax is due on a withdrawal from a Roth, whereas income tax is due on a regular IRA. Early withdrawal penalties are generally imposed on early withdrawals from either a Roth or traditional IRA, but there are exceptions, and you should consult with a tax advisor. In general, your divorce attorney may prepare a Qualified Domestic Relations Order (QDRO) in order to permit eligible retirement funds to be rolled over tax-free incidental to a divorce.
9. The sale of your home has tax consequences. If you are selling your house due to a divorce, ataxpayer generally is not subject to tax on the first $250,000 of capital gains ($500,000 for a married couple filing jointly) when a residence is sold, if the house was the principal residence in any two of the five years prior to the sale.
If the house was purchased recently and you don’t meet the two year period of residence, the IRS may allow a partial exemption when the sale of the house is due to divorce or separation.
10. Staying in the marital home after the divorce and taking sole ownership? Be aware of the tax implications when the house is eventually sold. When real property is transferred during the divorce, the spouse receives it with the same basis it had prior to the transfer. This can have a huge tax effect if the property has appreciated considerably since it was purchased.
Don’t forget transfer tax on real estate. There’s generally no federal income tax due on the transfer of real property as part of a divorce. However, New York State requires payment of transfer tax when the deed is recorded. This can be a significant amount and should be part of the divorce negotiations.
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Yvonne Cort, Esq. is a Partner at Capell Barnett Matalon & Schoenfeld LLP https://cbmslaw.com/team/yvonne-r-cort/, where she focuses her practice on IRS and NYS tax controversies. Yvonne can be reached at ycort@cbmslaw.com or 516.265.1116.
Disclaimer: The information in this article is provided for informational purposes only. The information is not legal advice and it is not intended to be legal advice. You should consult an attorney for advice regarding your individual situation.
