Tuesday, January 19, 2010
Filing Taxes After Divorce: Advice from the Expert
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Many clients come to me with questions about filing taxes in the first few years after their divorce becomes final. Filing taxes as Single or Head of Household is new and can be anxiety ridden for many women, until they get clear on how to proceed. I find that the clients I work with get through the process and come out feeling stronger, having learned a lot about themselves and their finances in the process. Here is an example of an email I received from a new client recently:
Dear Gabrielle,
My divorce was final on December 3, 2009. My husband always prepared and filed our state and federal income tax returns. This is the first year that I must file my on my own and I have a few questions:
- Since I was married for most of the year, what is my filing status?
- My husband always made a tax deductible contribution to my IRA. I do not work but I get $24,000 a year in alimony. Can I make an IRA contribution?
- Do I have to report or claim any of the assets that I received in my divorce?
Sarah F.
Andover, MA
Dear Sarah,
Preparing your income taxes for the first year following your divorce can be a daunting task. However, with the help of a good accountant and/or tax preparation software, you will get through it, and learn a lot about your finances in the process.
I. Filing Status:
To determine your filing status for the year, the IRS looks to your marital status as of December 31. If your divorce was final and you were considered unmarried in the eyes of the law on that date, then you would file as Single or Head of Household. You are able to file as head of household if you meet all the following requirements:
- You are unmarried or “considered unmarried” on the last day of the year.
- You paid more than half the cost of keeping up a home for the year.
- A “qualifying person” lived with you in the home for more than half the year (except for temporary absences, such as school). However, if the “qualifying person” is your dependent parent, he or she does not have to live with you.
II. Individual Retirement Account (IRA):
According to the IRS, all taxable alimony you receive under a decree of divorce is treated as compensation for the contribution and deduction limits for traditional IRAs. This means that you are able to offset your taxable alimony with a tax deductible contribution to your own IRA. One of the basic tenets of financial planning is to Pay Yourself First. This is a great way to save for the future while reducing your income tax liability, especially if you didn’t pay quarterly estimated tax payments throughout the year. If you are under age 50, the contribution limit for 2009 is $5,000 ($6,000 for Age 50 and over).
III. Taxation of the Transfer of Assets Between Spouses:
In general, no gain or loss is recognized or reported on a transfer of property from you to:
- Your spouse, or
- Your former spouse, but only if the transfer is incident to your divorce.
This rule applies even if the transfer was in exchange for cash, the release of marital rights, the assumption of liabilities, or other consideration. For example, if you received your husband’s 401(k) as part of your divorce agreement, and subsequently rolled those funds into your personal IRA account, then that is not a taxable transaction and you do not need to report it. However, you will be responsible for the income taxes due when you withdraw funds from the IRA when you retire. If you withdraw funds prior to age 59 ½, you must pay the income tax due as well as a 10 percent early withdrawal penalty.
The learning curve is very steep the first year after your divorce, on so many levels. But press on, be confident in your ability to understand your finances, and surround yourself with knowledgeable, experienced professionals to assist you. I promise next year will be easier!
Best,
Gabrielle
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