Divorce and Taxes

Divorce - and the process of - certainly makes for a difficult time, and a major life change. It can also complicate your tax return.

On the front end, the best thing to do is to take an active role in how your divorce decree is written, and understand the terms within it. (Of course this is good advice regardless of your taxes.) The more familiar you are with the divorce agreement and its terms, the easier time you'll have understanding the effect your divorce will have on your taxes.

Here are some of the divorce-related terms and what they can mean at tax time:

Alimony
Alimony is both deductible and taxable. So it's important for both the payer and recipient to have alimony payments clearly defined in the divorce agreement.

As the payer of alimony, you don't have to itemize to claim it as a deduction. It's considered an "above the line" deduction.

If you are the receiver, you can avoid a big tax bill at the end of the year if you pay estimated taxes as you receive payments. On your tax return, you'll report alimony on line 11, Form 1040.

Child Support
Child support is not deductible by the payer, and it does not have to be claimed by the recipient. Your decree should include a definitive ending period for child support not related to the age or any life changes of your children.

Children as Dependents
If you're the custodial parent you can claim the child as a dependent. However, the noncustodial parent can claim the child for a dependent deduction with the consent of the custodial parent. The custodial parent can "release" the child for this purpose using Form 8332 from the IRS. The custodial parent may still qualify as Head of Household.

Custody should be spelled out clearly in the decree. If there's any confusion, the IRS may have cause to disaffirm the claiming rights of either parent.

Head of Household Status
If you're wondering whether you can qualify as Head of Household, there are several factors that will determine if you're eligible. Here are a few:

• You have to be either unmarried or considered unmarried by the last day of the year.

• To be considered unmarried, you must file a separate tax return, and you cannot have lived with your spouse during any part of the last six months of the tax year. Your spouse is considered to have lived in your home even if he or she is temporarily absent due to special circumstances.

• Your home must have been the main home for your qualifying dependent(s).

• You must also have paid more than half the cost of keeping up your home for at least half the year for you or any qualifying dependents (i.e. children, foster children (for the entire year), grandchildren, stepchildren, etc.).

• You must be able to claim an exemption for the qualifying dependent. However, you can still meet this test if you cannot claim the exemption only because the noncustodial parent is allowed to claim the exemption for the child.

IRAs and Tax-Sheltered Annuities
How will the divorce affect your IRAS and Tax-Sheltered Annuities? That should be addressed in your Qualified Domestic Relations Order (QDRO). A QDRO is a decree, judgment or court order that, among other things, relates to benefits paid to your child, spouse, former spouse or dependent. Consult Publication 575 from the IRS to see how the QDRO applies to your specific circumstances.

Divorce vs. Annulment vs. Separation
The IRS views all three - divorce, annulment and separation - the same. The way your taxes are affected depends on how your decree is worded.

Be aware that in cases where state law differs from federal law, the IRS will side with the federal government. Even judges' opinions can be overruled. Protect yourself by understanding the nuances of your divorce agreement and their implications.