Disclaimer. The following information is intended for general informational purposes only and does not represent tax advice to any individual or entity, either expressly or implied. Laws and regulations vary by jurisdiction and may change frequently. Compliance with such standards depends on one’s particular circumstances. Any reliance on this information is solely at the user’s own risk. Before making individual or business tax decisions, you are encouraged to seek professional tax advice.
TAX TIPS FOR ATTORNEYS
IN FAMILY LAW
©2011 Kent Rackett
KENT RACKETT, Esq.
Tax & Business Lawyer
1350 Connecticut Avenue Suite 850
Dupont Circle, Washington, DC 20036
I. Tax Considerations in Divorce & Separation
Divorce proceedings have numerous tax repercussions that pose challenging planning considerations for separated and divorced taxpayers, including the change in tax filing status, and the treatment of certain income and deductions related to children, alimony, property transfers, and the marital home. Thorough review of the tax effect is essential for negotiating equitable divorce settlements.
Tax Tip – Attorneys fees and related expenses allocable to the collection of alimony and tax advice are deductible by your client and should be separately identified as such in the attorneys retainer or bill for legal services.
A. Filing Status. Only individuals who are married at the close of the tax year may file a joint tax return. Normally, filing a joint return produces a lower tax on the combined incomes of a husband and wife than would result by filing separately.
Tax Tip – Where a vengeful spouse may be unwilling to file jointly, resulting in a higher separate tax, the other spouse may want to demand compensation in the property settlement agreement for the higher tax incurred.
Spouses who are legally separated under a decree of divorce or separate maintenance are not considered married for tax purposes. Unmarried taxpayers must file as single unless they meet the requirements for filing as head of household, which has lower marginal rates.
Tax Tip – A married taxpayer with a dependent child, whose spouse was not a member of the household during the last six months of the year, may file as head of household as an abandoned spouse, by furnishing more than half the cost of maintaining a home (for over half the taxable year).
For Federal tax purposes, a marriage is defined as a legal union between a man and a woman only, in contrast to D.C., where same-sex couples may file jointly.
B. Tax Benefits of Children. Generally, the child of a divorced or separated parent qualifies for the dependency exemption of the parent that he or she resided with for the longer period of time during the tax year (known as the custodial parent).
Tax Tip – The custodial parent may waive the exemption in favor of the noncustodial parent in a higher tax bracket, resulting in tax savings that can be passed along in the form of child support.
Parents may not split the tax benefits arising from the dependency exemption, (such as the child tax credit and dependent care credit), although, in the case of multiple children in a family, each parent may claim a different child. In contrast, where a student is a claimed a dependent, qualified tuition and related expenses paid by the student are treated as paid by the taxpayer, even if paid by a third party.
Tax Tip – The custodial parent who claims their child as a dependent may claim an education tax credit for qualified expenses paid by the noncustodial parent on behalf of the student.
C. Alimony & Child Support. Alimony is a form of support that is taxable to the payee spouse and equally deductible to the paying spouse, making it a useful tool in shifting income to the spouse in the lower tax bracket. Additionally, alimony payments can be made to third parties for the benefit of the payee spouse, enabling support agreements to be fully deductible, where they may otherwise be limited.
Tax Tip – Medical expenses and certain costs to maintain a home paid on behalf of the payee spouse can be fully deductible by the payer spouse as alimony, rather than as an itemized deduction, which is subject to limitations.
In contrast to alimony, payments representing child support are neither includible in the income of the payee nor deductible by the payer spouse.
D. Property & Stock Transfers. Generally, no gain or loss is recognized on a transfer of property from an individual to or in trust for a spouse or former spouse if the transfer is incident to a divorce. Nonrecognition applies, even where the parties are acting at arms length, and the transferee spouse pays full consideration for the property.
Tax Tip – In deciding how to divide their assets, the parties should consider allocating assets with greater potential gains to the spouse in the lower tax bracket and allocating assets that have appreciated little or have declined in value to the spouse in the higher tax bracket.
E. Retirement Accounts. A spouse or former spouse of an employee may receive a tax-free rollover distribution from that employers qualified retirement plan as part of a court-approved property settlement.
F. The Marital Home. The nonrecognition rule applies to a spouses transfer of the martial home incident to divorce. If the home is later sold to a third party, gain up to $250,000 can be excluded from gross income, provided the spouse has owned and used the home as his or her principal residence for periods aggregating two of the five years immediately prior to the sale.
Tax Tip – The divorcing couple can shield up to $500,000 in gain from the sale of their principal residence, provided they have both used the home as their principal residence for periods aggregating two of the five years immediately prior to the sale.
II. Innocent Spouse Relief
Joint filers are jointly and severally liable for all income tax, related penalties, and interest, including later determined deficiencies, subject to innocent spouse relief. Spouses are relieved from liability if they establish that: 1) they did not know (and had no reason to know) of the tax deficiency; and 2) taking all facts and circumstances into account, it is inequitable to hold the unknowing spouse liable for the deficiency. In furtherance of equity, the IRS will now consider requests that had previously been time barred where the requesting spouse had failed to make the election for relief within two years after the IRS begins collection activities against them.
Tax Tip – Domestic relations factors that weigh in favor of the spouse requesting relief include whether he or she has been deserted or the victim of abuse by the non-requesting spouse, the requesting spouseâ€™s deteriorating mental or physical state of health, and whether the requesting spouse was a member of the same household as the nonrequesting spouse at any time during the 12-month period ending on the date of the request for relief.
III. The Adoption Credit
Taxpayers who adopted (or attempted to adopt) a child and have paid qualified expenses relating to the adoption may claim a tax credit for as much as $13,170. Qualified expenses include adoption fees, court costs, attorney fees, and travel expenses. Expenses associated with a foreign adoption, in which the child was not a U.S. citizen or resident at the time the adoption process began, qualify only if the adoption is finalized.
Tax Tip – If you adopt a child with special needs (as determined by the State), you may qualify for the full amount of the adoption credit, even if you incurred little or no adoption-related expenses.
Taxpayers whose employer has paid for adoption expenses under a qualified adoption assistance program may exclude from income $13,170 that would ordinarily be taxable as a fringe benefit on their W-2. One cannot claim a credit for the same adoption expenses used to claim the income exclusion.
Tax Tip – For purposes of utilizing the maximum tax benefit of $26,340 (either as a credit or exclusion from income), the employer reimbursement should not exceed half this amount.
In past years, the adoption credit was nonrefundable (meaning tax liability was reduced to zero, but not below), but one could carry any unused credit forward. Under the 2011 Affordable Care Act, the credit is now refundable, reducing tax liability to zero, with the IRS refunding any remaining credit in the current tax year.
Tax Tip – Taxpayers who incurred adoption expenses in prior years, but did not claim the credit because they did not owe tax, may amend their previous years returns in order to claim a current tax refund.
About the Author: KENT RACKETT is an attorney admitted to practice in the District of Columbia and New York. Having successfully passed the CPA exam after college, he pursued his interest in tax by working for accounting firms before attending New York Law School. He focuses on helping individuals and small businesses save money, while protecting and enforcing their rights in the areas of tax counseling, business law, estate administration, elder law, and government benefits. Having relocated from Manhattan to D.C., he still serves as a court-appointed guardian for minors and the elderly in New York City. As a niche, he serves as an accountant and consultant to attorneys, assisting them in setting up their practices, accounting and preparing tax returns, and consulting on aspects of tax law that arise in connection with their clients legal matters.
IRS Circular 230 Disclaimer: Any tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any tax-related matter addressed herein.