Choosing a Tax Filing Status for Divorcing Couples
Choosing a Tax Filing Status for Divorcing Couples
M. Tilden Moschetti, Law Offices of M. Tilden Moschetti, San Francisco
Introduction
Marital Status
Married Filing Jointly
Married Filing Separately
Head of Household or Single
Conclusion
Introduction
Of all the issues that come through the doors of the family law attorney, taxes are often the most difficult to fathom. Law schools, undergraduate institutions, and continuing education leave us little prepared for the inevitable phone call. “My accountant wants to know,” the client says, “how to file last year’s return.” The answer is not always easy or clear-cut. The right decision can save the client money and exposure from liability. It can also change the levels of support to the benefit of the client and the client’s spouse.
Marital Status
People who are divorced or legally separated before the end of the taxable year cannot file a joint return. They must file as either Single or Head of Household. See Boettiger v Commissioner, (1958) 31 TC 477. However, the couple in the process of dissolution may still be treated as married for tax purposes even though they are living apart. (IRC §7703(b)) There are two thresholds in determining whether the couple should file as married. First, there must not be a court decree of separate maintenance. Second, the “abandoned spouse” rule does not apply.
A decree of legal separation is a court order to live apart and is totally unrelated to a requirement to make support payments [but may contain an order for spousal or child support]. (Separate maintenance was replaced in California by legal separation under the 1969 Family Law Act.) Thus, separation even with a separation agreement or pendent lite orders of support without a decree of separation does not preclude spouses from using the “married” filing status. The decree must alter the marital relationship by requiring the couple to live apart. At this point, it is unclear if a domestic violence order made in connection with a dissolution case would be enough of a decree to preclude a couple from filing as “married” for tax purposes.
An individual may qualify as unmarried under the so-called “abandoned spouse” rule. For tax savings, the “abandoned spouse” status is often the most favorable. The abandoned spouse does not need to follow the Married Filing Separately provisions, may itemize deductions regardless of how the other spouse files, and is eligible to file as Head of Household. Married spouses who cannot qualify as an abandoned spouse must file either as married filing jointly or married filing separately.Married Filing Jointly
Simply put – the Married Filing Jointly status is used by most couples who are married as of the end of the tax year. When filed jointly, income and deductions are reported on the same return as the other spouse. A joint return will normally expose both spouses to joint and several liability for any tax due on the return. For the lower earning spouse, there is often little reason for that spouse to want to file this way. When the lower earning spouse will be receiving support, however, it is often in the client’s best interest to file jointly to raise the net income of the paying spouse so the client may receive a higher level of support. A compromise typically is reached by the couple signing “hold harmless” agreements for the liability exposure. Providing them with an accounting that depicts a lower tax burden means more net income for the paying spouse and more support for the supported spouse. Another disadvantage to filing jointly may arise when itemizing deductions. Many of the deductions are limited by a percentage of income, e.g., medical expenses which have a 7.5% floor on adjusted gross income before deduction. IRC §213(a).
It is also important to remember that married taxpayers may amend the filing from Married Filing Separately within three years of the filing due date. IRC §6013(b). So, even after taxes have been filed, that return may be amended for the benefit of the couple.
The last major concern for divorcing couples is the effect of filing status on separation date. In California, there have been no major opinions that have said the tax filing status is determinative of separation. However, the courts have considered it as a factor in determining the appropriate date. (In re Marriage of Norviel. (2002) 102 C4th 1152 at 1156 and In re Marriage of von der Nuell (1994) 23 C4th 730 at 735.) In order to alleviate serious problems, I advise drafting a stipulation that makes the intent of the filing clear to both parties, makes performance clear as to who gets what, and clarifies that the filing status is not to be considered as a factor in determining separation date.Married Filing Separately
There are many downsides to filing separately, the most serious being the loss of credits and deductions. For example, the Child and Dependent Care Credit and the Earned Income Credit, education credits of the other spouse, etc. Credits for higher education are not available for people filing separately. This is not to say that both parties will necessarily lose all credits, but because the limits of credits or deductions are higher for married persons, the benefit may have to be carried forward for the credited spouse.
Head of Household or Single
If the client is not married at the end of the tax year, he or she must file as single or as head of household, unless the “abandoned spouse” rule applies.
Conclusion
In the family law context, lawyers frequently refer clients to accountants for expert advice on tax, accounting, and valuation matters. However, when dissolution is underway, most often it is the accountant or the client, calling the attorney for advice of what the appropriate filing status should be.
