FORENSIC CPA

Year end tax planning during a divorce

Walker & Company CPA, provides forensic accounting and litigation support services to attorneys working in the family law area.

This publication is intended to be informative and educational. It does not replace the services of a competent professional which should be sought before relying on this information.

Volume 1, Issue 2

October 15, 1997

The last quarter of the year is typically the period of year end tax planning for CPA’s. Since the majority of our clients are those going through a divorce, we look a little differently at seeking tax planning opportunities compared to other CPA firms.

Here is an example of a tax planning opportunity that, in the correct circumstances, can save several thousand dollars for a couple going through divorce and needing to file their 1997 return.

First the case facts: Say the couple separated in 1996. The wife is a mother and runs the household with no income. The husband is a high wage earner. These are the only sources of income.

When the couple separated near the end of 1996, the husband started paying his wife a voluntary support amount to cover the household and living expenses of the family.

It is now October 15, 1997 and you have just acquired one of the spouses as a client. There has been no petition filed for divorce yet.

The above case facts are not unusual. However, with a little tax planning, the couple could save some substantial tax dollars. Remember, the only real bad guy in a divorce is Uncle Sam. If there are some tax savings that can be shared by the couple, then both spouses come out winners.

Current Problems:

No petition has been filed, so the June 30 or six months waiting period has been missed to be divorced by year end. The filing status is determined on the last day of the calendar year, which is December 31, 1997. Since the couple are not divorced by then, the only "current" filing status available is married filing jointly or married filing separately. Married filing separately does not help (nor head of household) because the wife has no income and therefore, it would be best for the husband to claim the wife as a exemption. The lowest tax status would be to file a joint return as in the past. No tax savings are enjoyed.

Remember, the voluntary support the husband is paying does not qualify as alimony by the IRS. Therefore, the amount is not tax deductible by the husband nor taxable to the wife.

A retroactive order will not help because normally, unless by correction of an unusual error, the IRS will not allow a retroactive order to be treated like alimony.

It would be ideal if the husband could get deductibility, and thereby shift income over to the wife’s lower tax bracket to save taxes. In addition, if they could be single, there would be two unrelated taxpayers and one can take the itemized deductions and the other an additional standard deduction saving even more taxes.

Solution

Many people are not aware that there is not a six month waiting period to get divorced for tax purposes. All you need is a judgement of legal separation filed before the year end. A judgement of legal separation for tax purposes is sufficient to be considered divorced and each party can file their own separate return.

Voluntary support is not tax deductible. A retroactive order will not make it so. The key is that the alimony payment must be per written agreement or court order prior to the actual writing of the check. Therefore, it is simple to get the voluntary payments for 1997 deductible by writing a current order for the total payments of voluntary payments made in 1997 up to the order. Once the husband has the written order, he then makes a check out to the wife for the lump sum amount and the wife makes an equal check out to the husband to repay him for the "loans" he has advanced her during the year. Now the husband has a written order and a canceled support check to his wife after the order to substantiate the deductibility of the support.

Summary of key points to remember:

To be legally separated, the judgement ( Judicial Council Form 1287) will be checked "legal separation" and a date entered indicating the date of entry.

Since there is no six month waiting period to obtain a judgement of legal separation, this is an option to consider if single returns yield substantially lower tax obligations than a joint return and no petition has been filed by July 1 of that year.

Voluntary support is not deductible by payor and a retroactive order generally is disregarded for income tax purposes.