Welcoming The Third Spouse: The IRS

In a typical divorce case there generally appear to be three key players: a husband, a wife, and the Internal Revenue Service. There are a number of key areas in a divorce case impacted by tax law, and unless parties are properly counseled about the tax impact of their decisions, in some instances the impact can be negative.One of the key areas impacted by tax law is the sale of the marital home. For purposes of assessing capital gains, tax law defines the principal residence as the home where the parties lived for any two of the last five years. If the home being sold is at least one of the parties‣ principal residence for two of the past five years when it is sold, each individual is allowed to exclude up to $250,000 of the gain from taxable income if single, and $500,000 as a married couple.

Another area in a divorce case which is impacted by tax law is the area of exemptions for the children of the marriage. Among the many disagreements between divorcing couples, one fight among couples with children is the fight about who is entitled to the tax exemption in a given year. Generally, the IRS assumes that the spouse who has custody of the children is entitled to the exemptions. Of course parents are allowed to trade the exemptions back and forth freely using IRS Form 8332. Parents with multiple children have the option to split the exemptions, however parents often fall into this pitfall and what appears to be a fair split, at times prevents parties from maximizing their tax savings. The best approach as it relates to exemptions is to consult an attorney who can calculate the value of the exemptions so that both parties‣ tax savings are maximized each year.

Another key area pertains to the tax filing status. Tax filing status is determined by the parties‣ status on December 31st of each year. If divorced or legally separated as of December 31, the parties file as single taxpayers for that year. However, if still married as of December 31, parties who lived in the same household must file as married. Another tax filing status is head of household. If you are unmarried, you can qualify to file as head of household if for more than six months of the tax year, you paid more than one half of the cost of maintaining a home for yourself and a qualifying person. On the other hand, if you are married, you can qualify to file as head of household if you pass the qualifying test, which, among a number of steps includes you having paid for more than one half of the cost of maintaining a home for yourself and a qualifying person and your spouse can not have lived with you for the last six months of the tax year. As head of household you‣re entitled to more generous tax brackets and a bigger standard deduction.

So, if you‣re separating, or divorcing, or contemplating either of the two, you should strongly consider consulting with an attorney who will assist you in assessing the potential tax consequences of your decisions so that you can safely maximize your tax savings each year.