Since We are Separated Now, Should We File Separate Tax Returns?
During the time that a couple is separated, and prior to the divorce decree, it can be quite confusing to determine how to file the income tax returns. There are many filing statuses
During the time that a couple is separated, and prior to the divorce decree, it can be quite confusing to determine how to file the income tax returns. There are many filing statuses that seem to be available, but how do you know which one is right for you? Married Filing Joint? Married Filing Separate? Single? Head of Household? The filing status that you use for a tax year is determined based on your marital status on December 31. Let’s look briefly at each filing status.
Single
This filing status is only applicable after the divorce has been finalized. Once the divorce is final, this filing status is used for any taxpayer who does not provide the main home for more than half the year for a dependent.
Head of Household
Typically, this filing status is only available after the divorce and is available to the parent whose home is the principal residence for more than half the year for one or more of the children. In limited circumstances, a taxpayer may be eligible to file a tax return using the Head of Household filing status prior to divorce. In order to qualify, all of the following tests must be met:
Taxpayer files a separate tax return
Taxpayer paid more than half the cost of keeping his or her home for the year.
Taxpayer’s spouse did not live in the home for the last 6 months of the tax year.
Taxpayer’s home was the main home for more than half the year for a dependent child.
Tax rates for the Head of Household filing status are much closer to the tax rates for Married Filing Joint and, therefore, this can be an advantageous filing status for some taxpayers who are separated from their spouse but not yet divorced and for whom the Married Filing Joint filing status is not an option.
Married Filing Separate
While it may seem like the logical choice after you have separated, the general rule of thumb is that the worst tax rates are applied to those who choose Married Filing Separate. More income is taxed at higher tax rates, and several credits and deductions may be lost. There are limited occasions where the Married Filing Separate may be a more advantageous filing status from a tax perspective, but they are rare. And there may be some circumstances where, although the tax incurred will be higher, this filing status is a more prudent choice for a taxpayer.
Married Filing Joint
In general, this filing status offers the best tax rates for more of a family’s income and allows several more credits and deductions to be used. If at all possible and prudent, I recommend that clients work toward filing jointly until the divorce is finalized.
Cathlean Utzig is a CPA and Certified Divorce Financial Analyst with her own private tax practice focusing on individuals, small businesses and families in transition.
What Happens to Our Retirement Accounts Once We Divorce?
Deciding how to divide the retirement accounts, such as IRAs, 401(k)s and pensions is an important part of the divorce process.
Deciding how to divide the retirement accounts, such as IRAs, 401(k)s and pensions is an important part of the divorce process.
Unlike closing a joint bank account and opening a new one in your own name, for example, dividing retirement assets can be a bit complicated.
We all know that taking a distribution from a retirement account will likely result in income taxes and possibly a 10% penalty. Fortunately, there is an exception to this rule when retirement assets are distributed due to a divorce.
A qualified retirement plan, meaning a 401(k) or pension, can be divided if a Qualified Domestic Relations Order (QDRO) is prepared, spelling out how much is to be distributed and to whom. This allows the retirement account to be divided without taxes and penalties.
The spouse receiving the assets can roll them into an IRA rollover account at the financial institution of their choice. The QDRO allows the funds to be distributed out of the original 401(k) but they must be rolled into an IRA to avoid tax. Once the assets are in the IRA rollover, they are treated just as any other IRA.
There is a one-time opportunity to take some of those funds in cash without penalty before the funds are rolled over. The decision to take out this cash must be made carefully. Although you may avoid a 10% penalty, the cash you take without rolling it over will likely be subject to income taxes. And it will reduce your overall retirement assets which may be needed later.
When it comes to dividing a pension plan, some allow distribution of a portion of the current cash balance which may be rolled into an IRA. Some require distribution of a portion of the monthly payments upon retirement. The difference between these two options is controlled by the pension plan document, and the plan administrator will explain the options of your particular plan. A QDRO will be required for this to be properly documented either way.
There is no plan administrator for an IRA and they don’t need a QDRO; but many financial institutions require a copy of the final Divorce Decree. Your attorney might be able to facilitate this sooner by preparing another type of less complicated order to satisfy the requirements.
The decision of how to divide your assets and the consequences of each, whether real estate, retirement or other investments is one of the most important decisions you will make during this process. Your collaborative divorce team is well aware of this and they will work closely with you to help you through the process.
By Diane Willis
What are the Basics of Alimony?
Alimony is effectively a distribution of income from one spouse to another in a divorce. It tries to alleviate any inequity in income earned by each spouse.
Alimony is effectively a distribution of income from one spouse to another in a divorce. It tries to alleviate any inequity in income earned by each spouse.
There are “rule of thumb” equations to estimate alimony. However it is difficult to assess a global standard because each divorcing couple’s situation is unique. In general, alimony considerations include:
Need. An attempt is made to determine the amount of need a recipient spouse has for basics such as food, residence and general living. Other costs are also considered such as discretionary expenses and goals resulting from the divorce (e.g. career services). Divorce professionals can help define a fair budget and will also assess the recipient spouse’s sources of income.
Ability to Pay. The ability of the payor spouse to pay alimony and still have enough to live on for himself or herself is also considered.
Length of Marriage, Age, Health, Need for Education, Etc. There is a variety of other factors that are considered when determining alimony. For instance, a lengthy marriage where one spouse sacrificed his or her career for the other will likely warrant a greater alimony obligation than a shorter marriage where both spouses have developed careers.
A popular belief is that alimony is supposed to afford a continuance of pre-divorce lifestyle. Often times, the circumstances of divorce require- that both spouses experience a decreased standard of living, especially initially.
By Geoff Owen
How do I adjust to life financially after divorce?
The financial adjustment to divorce commonly gets pushed to the back-burner as the process unfolds. This is understandable given the emotional toil and the nature of “putting out the fire
The financial adjustment to divorce commonly gets pushed to the back-burner as the process unfolds. This is understandable given the emotional toil and the nature of “putting out the fire immediately in front of you.” However a divorcee’s long-term financial stability and life planning benefit from early recognition of financial matters.
The cornerstone of assessing your financial circumstance is developing a post-divorce budget. When preparing a budget, it is important to weigh non-discretionary unavoidable costs versus discretionary costs because it is probable that your lifestyle will be reduced at least temporarily. Expenses being established, then you should inventory your income sources such as earned income, income from investments, alimony, and child support.
The budgeting exercise should help you visualize the likelihood of goals such as your need for earned income or whether you can afford to remain in the marital residence. It may also help you foresee beyond the short-term, for instance with retirement planning goals. Lastly, such contemplations will hopefully lead you to consider matters like changing beneficiary designations on retirement accounts and revising your estate planning.
As a part of budgeting and financial planning, you will want to manage your debt to achieve financial freedom. This may be simple cost-cutting and aggressive debt reduction to more complex strategies of debt consolidation.
Similarly, your credit rating will be important to borrow at favorable terms when you need to. You should start by reviewing your credit report and paying bills in a timely fashion.
It is important to transfer risks when going through the divorce transition. You should conduct a full review of basic insurances like auto, home, and health to the more intricate like life and disability.
By Geoff Owen
What should we do about life insurance when getting a divorce?
Divorce doesn’t eliminate the concerns you insured against as a married couple. In fact new needs are generated.
Divorce doesn’t eliminate the concerns you insured against as a married couple. In fact new needs are generated.
The child support-paying spouse may be the noncustodial parent, but he/she will still want to ensure the children’s basic needs are met and provide for major aims such as education expenses even if deceased. In addition, costs for childcare could rise significantly if the custodial parent dies. Consequently, it may be advisable for the noncustodial parent to purchase life insurance on the custodial parent.
Similarly, the support-receiving spouse has an interest in protecting payments against an untimely death of the payor spouse. As the beneficiary on the ex-spouse’s life insurance policy, the payee would receive insurance proceeds upon the payor’s death. However, the payee beneficiary lacks control of the policy if not also the owner. The payee would not know if the ex-spouse ceased paying premiums, took out a loan on the policy, or even changed the beneficiary. If structured as part of the divorce agreement, ownership of the payor’s policy can be transferred to the support-receiving spouse who is also the policy’s beneficiary and the transfer of ownership can avoid gift taxes. Premiums may qualify as alimony if paid by the payor spouse for life insurance on the payor’s life and if the supported spouse is the owner and beneficiary of the policy.
A less common approach is for the supported spouse to purchase a policy on the payor spouse. He/she would gain control as with the transferred ownership, however it may be expensive and there may be reluctance on the part of the payor spouse to undergo the underwriting requirements.
By Geoff Owen