California Divorce and Family Law

Divorce qualifies for capital gains exclusion

Q: I was told by a prominent accountant that there is a loophole in the law that states that you can be exempt from paying capital gains (if you are in a home less than the two-year period) if there are "unforeseen circumstances" involved. Are you aware of this? At the time I was going through an "unforeseen" divorce.

A: In general, in order to take advantage of the up-to-$500,000 exclusion of gain ($250,000 if you file a separate tax return), you have to own and live in the house for two out of the five years before it is sold. But the law does allow a partial exclusion under certain circumstances.

There are three "safe harbors," meaning that if you meet these tests the IRS will not challenge you: 1) changing to a job that is at least 50 miles farther away; 2) major health problems; and 3) unforeseen circumstances. In this third category, if you could not have anticipated an event before you purchased your house, you may also be able to claim a partial exclusion.

While this is fact-specific - and in many cases you will have to get a special ruling from the IRS - there also are some safe harbors that the IRS will recognize. These include: an involuntary conversion of your house; natural or man-made disasters resulting in a casualty to your home; divorce or legal separation; and multiple births resulting from the same pregnancy. It would appear that you may qualify based on your divorce.

The exclusion is equal to the number of days of use times the quotient of $500,000 divided by 730 days. Note that 730 days is two full years. If you are single - or do not file a joint tax return - change the $500,000 to $250,000.

Your accountant knows what he is talking about, so you should ask him to do the calculations. But I do not think he said that you can escape all capital gains tax.

From the San Francisco Chronicle.

Divorce muddies water in real-estate transaction

Question: My husband and I sold our home nearly two years ago and moved into a condominium that we own jointly. He has now left me, and he wants a divorce. I will be living in the condo until it's sold and we divide the proceeds. Will we be able to exclude capital gains on the sale of this property as our principal residence because we had just sold our home?

Answer: While individuals are allowed to exclude the capital gains generated from the sale of personal residences an unlimited number of times (up to $250,000 of gain each per sale for individuals), there must be at least two years between the sales.

If fewer than two years have passed between sales, you might be able to prorate the exclusion depending on the facts.

Because many homes are sold as a result of divorce, the law recognizes the special problems associated with divorcing couples.

In order to allow the "departed" spouse to either attain or retain the required two-year occupancy needed to qualify his or her ownership interest for the full capital-gains exclusion, the law allows the departed spouse to count the time the other spouse occupies the residence just as if the departed spouse was still living in the home.

However, it is important to remember that this "tacking" can take place only if the remaining spouse is authorized to continue occupancy pursuant to court order or marital agreement. And if one spouse purchases the interest of the other incident to a divorce, the purchasing spouse will be allowed to take advantage of the selling spouse's period of ownership. Here, we suggest that your property not be sold until at least two years have passed from your prior sale, but be sure to check with your tax adviser.

From the Orlando Sentinel.

Divorce, death pose tax twists

I always enjoy reconnecting with clients during tax season. Many times joyful events have occurred during the year, such as marriage or the addition of a child to the family. These positive events often have a favorable impact on their tax return.

Unfortunately, difficult situations also arise that bring challenges to the preparation of the tax return. Many of my clients are aging and are facing health problems. Sadly, some clients had to cope with the death of a spouse in 2007. A sound record-keeping system and the help of a family member or close friend can be extremely important in situations such as these.

On top of the emotional strain, the tax implications of divorce can be very unsettling, especially because of community property laws. In Texas and other community property states, communal assets are distributed equally, regardless of who earned more or spent more during the marriage. The courts typically allow the couple a certain amount of flexibility in deciding how to divide things.

Even if assets are split equally in dollar amount, certain assets may have less favorable tax treatment than others.

The two largest assets most couples hold are typically a house and retirement plan assets. In most cases a home can be sold with no tax impact, whereas the liquidation of retirement plan assets is a taxable transaction. If the retirement plan assets are sold before the account holder reaches age 59 1/2, the IRS assesses an additional penalty of 10 percent.

Stocks and bonds held in taxable accounts could generate capital gains or capital losses.

One approach to an equitable distribution of assets in a divorce would be to segregate assets by categories -- for example, cash and money market accounts, retirement assets, taxable stocks and bonds, personal property and real estate. Then assets in each category could be split evenly. This approach may not be appropriate if one spouse wants to keep the house; if the home represents a large portion of the total assets, this will skew the distribution. In this case, it may be best to hire a financial professional to assess the tax impact of various allocation approaches.

Divorce courts typically allocate the couple's debts evenly, but many creditors ignore this allocation and hold both parties liable. In some cases, there may be protection under the IRS Innocent Spouse provisions.

I typically suggest that clients pay off all joint liabilities before dividing asset accounts and close all joint accounts. In most cases mortgage debt can be assigned to the spouse who will keep the house.

Taking these extra planning steps during the divorce process will eliminate having to address financial problems after the divorce, when an amicable settlement is less likely to be reached.

More at the El Paso Times.

Five Ways to Save Tax Money During a Divorce

Taxes are probably the last thing on the mind of someone going through a divorce. But maybe they shouldn't be. Here are some money-saving tax tips to consider if you're getting divorced

The first thing certified divorce practitioner Clay Caldwell tells his clients is to “reach agreements with each other.” It’s very important, he said, to talk with your spouse and straighten out money issues. It’s very easy to lose money if the separating couple isn't communicating.

Decide the best way to file your taxes

There are three options when filing for taxes. Filing as "Head of Household" saves you the most money and varies with income. In order to qualify under this label, you must pay more than half the cost of keeping up the home and a qualified person, such as a child, must be living with you.

The second option is to file jointly. If you have not filed for divorce before Dec. 31, filing jointly is more beneficial to you and your spouse, according to experts. Joint filing means you are both responsible for all taxes and are each entitled to a prorated share of any refunds. It also puts you in a better tax bracket. If there are additional taxes or penalties because of fraud or negligence on past returns, you could qualify as an "innocent spouse," according to Caldwell. 

Filing separately is the last way to file. This option usually means paying the most taxes. The good news, however, is that you are only responsible for your own taxes. 

Choose who will claim the children

Deciding who will claim the children depends on many things. Couples should figure out who has the higher income and who sits in the better tax bracket. The parent who establishes custody gets a dependency exemption, which could come to about $3,000 per child.

Child support is not tax deductible because it's considered something you'd pay whether or not you are divorced. However, alimony or “maintenance” is tax deductible.

Preserve assets 

State tax laws differ on divorce. Some states, such as Texas and California,are known as common law or community property states. These states treat all property owned by a married couple as a shared asset. “When you file for divorce everything is subject to division,” said Ken Raggio, a Dallas-based divorce lawyer.

California,for instance, splits community property 50/50.

Property transferred between spouses isn't subject to taxes. But selling stocks, homes and vacation homes as part of a divorce are taxed. A jointly-owned residence that one spouse has been granted the use of is tax deductible contingent upon agreements between the couple and IRS regulations. "If the non-residential spouse has agreed to pay the expenses, half the mortgage payment may be deducted as alimony, and the other half deductible as interest expenses,” said Caldwell.

Follow up on beneficiary forms after the divorce

The last tip, and perhaps the most complex divorce tax issue is retirement. “Retirement rules are so complicated, without a lawyer people can lose a lot of money,” said Lee Rosen, a North Carolina tax divorce lawyer.

All retirement benefits including qualified and unqualified plans, vested or unvested stock options, restricted stock or any other form of deferred compensation are divisible in a divorce. The transfer of retirement benefits is not taxable. Retirement benefits from an ex-spouse are taxable as ordinary income when withdrawn. You will also be taxed if you use the retirement benefits before age 59½ or don’t roll them over the right way.

When it comes to taxes in divorce, people are getting a lot smarter because they don’t want to lose money, experts said. “Time is money in divorce law,” said Caldwell. It's very unlikely you will figure out all the tax issues alone with your spouse. Keeping that in mind, any professional tax advice prior to your divorce is tax deductible, so it may be worth it to get some financial guidance.

From Fox Business. 

Tax form can help in divorce

Question: I have been divorced for a few years. The divorce decree says I get to claim my daughter as a dependent and my ex is supposed to claim my son. The problem is that my ex beats me to the tax man every year and claims both children. What can I do to stop this?

Answer: You've learned that a divorce decree is typically binding only on the parties that agree to it -- and the Internal Revenue Service wasn't one of those parties.

The best way to protect your right to claim your daughter as a dependent is to have your ex-husband sign IRS Form 8332 waiving his right to claim her -- and you'll need to fill one out releasing your claim to your son. You need to fill out a separate form for each child.

Ideally, this would have been handled as part of your divorce.

"It really surprises me that divorce attorneys don't automatically include Form 8332 as one of the documents to be signed whenever child support comes into play," Rosenberg said.

If you can't get your ex-husband to cooperate, you're not out of options. If your daughter lived with you for more than half the year and you provided more than half her support for the year, and can prove both facts, Rosenberg recommends you "go ahead and file your tax return on paper, the old-fashioned way."

The IRS will challenge you, but if you can defend your position, you can prevail.

On the other hand, if you only provided support but your daughter did not sleep under your roof for at least 183 days (or otherwise met the "living with you" standard outlined in IRS Publication 501), you will lose the exemption.

"This is where getting that Form 8332 signed at the time of the divorce is so critical," Rosenberg said. "Without it, in a dispute, you lose. Sorry."

From the LA Times.

Marital status at the end of the year determines filing status

Q: My divorce was final in December 2007. How should I file my taxes? Can I file as single now or do my ex and I have to do one last joint return since we were married for the majority of 2007?

Answer from AICPA member Lisa R. Featherngill: Your filing status is determined on the last day of the year.

Thus, you can file single for 2007. If you have children, one of you may consider filing head-of-household to lower your tax rate.

For more information:     What is your Filing status? 

From USA Today.

Tax issues in divorce and separation

In the event of a divorce, the court has the authority to divide or allocate all the property and assets belonging to both parties. This includes pension plans, IRAs, and other retirement assets.

Pension plans, profit-sharing plans, 401(k) plans, 403(b) plans and other "qualified plans" are all subject to an "anti-alienation provision" under federal law that provides that the plans can not be assigned or subject to any type of attachment, garnishment or levy. In general, creditors, including divorcing spouses, cannot reach these plans. There is an exception for a Qualified Domestic Relations Order ("QDRO" pronounced "KWAD-row").

Under a QDRO, a spouse, former spouse, child or any other person who is a dependent may receive qualified plan assets belonging to the participant. A QDRO is a specific type of domestic relations order from a court that creates an alternate payee's right to receive all or part of the benefits payable under a participant's plan. It does not alter the amount of the benefits under the plan.

There are precise procedural rules governing how a QDRO must be created and administered. The QDRO must contain 1. the name and last known mailing address of the participant and each alternate payee; 2. the name of each plan to which the order applies; 3. the dollar amount or percentage (or the method of determining the amount or percentage) of the benefit to be paid to the alternate payee; and 4. the number of payments or time period to which the order applies.

A QDRO may not require a plan to provide an alternate payee with a form of benefit that is not otherwise available under the plan. A QDRO cannot require a plan to provide for increased benefits. It cannot require a plan to pay benefits to an alternate payee that are required to be paid to another alternate payee under another order previously determined to be a QDRO. (For example, a QDRO for the divorce from the second spouse can't change a QDRO for the first spouse.) Lastly, the QDRO cannot require a plan to pay benefits to an alternate payee in the form of a qualified joint and survivor annuity for the lives of the alternate payee and his or her subsequent spouse.

Since IRAs are not subject to the "anti-alienation provision" a QDRO is not necessary to divide an IRA. IRA assets may be divided in accordance with a court decree or a property settlement agreement approved by the court. The former spouse who receives part or all of the IRA is required to treat the assets as his or her own IRA. Be careful. If an individual gives IRA assets to a former spouse without a court decree or a property settlement agreement approved by the court and authorizing the change in ownership, the former spouse who withdrew part or all of the IRA will be required to include the transferred amount in income — that is, the IRA is treated as distributed to the owner.

An amount distributed to the former spouse from a Roth IRA is tax- and penalty-free, but an amount distributed in accordance with a separation agreement that was not approved by a court is not eligible to be rolled over or transferred to an IRA of the former spouse.

Divorcing spouses must remember to change all of their beneficiary designations.

Read more in Lancaster Online.

 

Tax tip | Divorce can impact taxes

This year, the deadline is April 17 for federal and state returns.

If you were recently divorced and are paying or receiving alimony under a divorce decree or agreement, you need to consider the tax implication for your 2006 federal income tax return.

Alimony payments received from your spouse or former spouse are taxable to you in the year you receive them. Because no taxes are withheld from alimony payments, you may need to make estimated tax payments or increase the amount withheld from your paycheck.

Alimony payments you make under a divorce or separation instrument are deductible if certain requirements are met. Any payments not required by such a decree or agreement do not qualify as deductible alimony payments.

Child support is never deductible. If your divorce decree or other written instrument or agreement calls for alimony and child support, and you pay less than the total required, the payments apply first to child support. Any remaining amount is then considered alimony.

For more information, go to the IRS website.

Source: The State.

Roses, Candy and Taxes: Tax Effects of Marriage, Divorce Life Changes Can Have Major Tax and Financial Implications

Whether you’re tying the knot or severing the tie, Valentine’s Day is a natural time to examine the tax implications of marriage and divorce. H&R Block offers these tax tips if you’re considering one of these life changes.

More than just wedding gifts and thank you notes, marriage also means planning for a joint financial future, including how the couple’s tax situation has changed: Marriage means choices.

The IRS allows married couples to file using the “married filing jointly” or “married filing separately” status. Each has advantages that can be difficult to sort out. For example, if you claim medical expenses or other itemized deductions that are limited by your adjusted gross income, filing separately may be the way to go. But if you want to claim most tax credits or deduct your IRA contribution, you’ll probably need to file jointly. Consult your tax professional to determine the right choice for your first time filing together.

Social Security numbers don’t change, but anyone who has changed their last name will need to apply for a new Social Security card. If the name and number don’t match, the IRS might delay processing of the return, which means a refund could take longer than usual to arrive.

Marriage also means adjusting retirement savings. Besides changing filing status on an employer’s 401(k) account, newly married taxpayers also should consider increased limits for tax-deductible IRA contributions. If the couple’s income meets certain limits, they could qualify for more of a deduction. In some scenarios, one spouse also may “borrow” from the other’s earnings to meet the limits.

Inform the IRS of a new address. If the IRS does not have the correct address on file for a newly married couple, it could take longer for a refund to arrive. Taxpayers shouldn’t count on mail to be automatically forwarded and should consider filing Form 8822 to inform the IRS.

Divorce also can change a taxpayer’s financial situation. The best advice is to understand the divorce agreement and its terms, especially key components that could complicate a tax return.

Alimony is taxable and deductible. The person who provides alimony can claim the payments as a deduction, while the person who receives it can avoid a large end-of-year tax bill by paying estimated taxes during the year. Unlike alimony, child support is not deductible or taxable.

Who claims children? The parent who has custody of a child usually can claim the child as a dependent. However, with the custodial parent’s consent, the parent without custody can claim the child. (The custodial parent may still be able to claim certain tax benefits related to the child, including head of household filing status, the Earned Income Tax Credit, and the child-care credit.)

Who is a head of household? There are several factors for determining the head of a household. A few include being considered “unmarried” on the last day of the year, having children or other dependents who live with you, and paying more than half the cost of providing a home for dependents. Taxpayers should consult with a tax professional to determine if they qualify for head-of-household status.

Divorce, annulment and legal separation are considered the same by the IRS for tax purposes. The way a tax return is affected by the situation depends on how the decree is worded, and in cases where state and federal law differ, the IRS will side with the federal government.

This article from dBusinessNews.

Deductibility Of Attorneys' Fees In Connection With Divorce

It’s that time of year again. Of course, the general rule is that lawyers’ fees and costs in connection with obtaining a divorce are not tax deductible. As with many general rules, there are exceptions:

1. Attorneys’ fees related to tax advice. I.R.C. §212(3). Areas having tax implications upon which an attorney may offer advice include the tax effect of the distribution of property, including retirement plans, tax deductibility of interest payments or installments to effectuate an equitable distribution of property, the allocation of the dependency exemption and child tax credit, whether a joint tax return should be filed, the tax effect of unallocated maintenance and child support, the tax implications of the form of alimony, and advice regarding the recapture of front end loaded maintenance in the first three years following separation.

Practice tip: it is not helpful for the client wishing to tax deduct some attorney fees to have a provision in the marital settlement agreement that no tax advice was given.

2. Attorneys’ fees related to the production or collection of taxable income may be deductible. I.R.C. §212(1). For example, the payee of taxable alimony may be entitled to a deduction for attorney fees in generating the production or collection of this taxable income and fees in connection with securing an increase in taxable alimony may also be deductible. Attorney fees for obtaining income producing property are not deductible, but could arguably be added to the tax basis of the property.

A taxpayer may deduct only fees paid to his or her own attorney, unless the fees of the other party are paid as alimony.

Any attorneys’ fees that are legitimate income tax deductions are deductible only to the extent that all of the miscellaneous deductions in the aggregate exceed 2% of the taxpayer’s adjusted gross income. There is also an “applicable amount” which may reduce the otherwise allowable deduction.

Lawyers must be very careful not to overstate the amount or portion of attorneys’ fees that relate to tax deductible advice or legal efforts. I.R.C. §6701, Penalties for Aiding and Abetting Understatement of Tax Liability.

From Diana Skaggs and the Divorce Law Journal.