Tax Concerns Related to Divorce

The significance of the tax implications of a divorce can not be overstated. The valuation of any proposed settlement agreement must include a close inspection of the likely tax effects. An agreement's value to a client cannot be accurately measured without understanding the tax consequences any proposed agreement may produce. The type of alimony one agrees to pay, for example, can have a significant impact on whether or not alimony payments are tax deductible - which can drastically alter an agreement's worth. I always recommend that clients meet with a tax specialist during the representation. The Law Office of Jonathan T. Day, PLLC maintains relationships with tax professionals so that clients can have access to exactly the expertise that they need. With that in mind here are some general answers to some of the most frequent tax questions divorcing couples may have.

Should I file jointly or separately?
What was your marital status on the last day of the taxable year? If your divorce was final on or before December 31, you must each file separately as single or head of household for that year. If the divorce was not final by the end of the year you must file as a married couple for that year (either jointly or married filing separately).

Is alimony taxable?
Alimony payments are taxable, and therefore may be claimed as a tax deduction for the payor and as taxable income for the payee (the person receiving the alimony payments). However, not all forms of Mississippi alimony are tax deductible. In order for a payment to qualify as alimony under the Internal Revenue Code the payment obligation must terminate on the death of the payee. Of the four types of Mississippi alimony, only two meet the Internal Revenue Code's requirements - periodic alimony and rehabilitative alimony. Just because you are paying alimony in Mississippi does not mean that you automatically qualify for an alimony tax deduction.

Is child support taxable?
No. Child support is not taxable and cannot be claimed as taxable income nor as a tax deduction.

Who gets to claim the children on their taxes?
By default, the custodial parent (defined as the parent who has custody for the greater part of the year) is entitled to the dependency exemption. However, the custodial parent may waive the exemption by use of IRS Form 8332. Additionally, how tax credits and exemptions are to be divided can be determined by agreement, allowing for parents to split them evenly or for a non-custodial parent to claim credits or exemptions ordinarily reserved for the custodial parent.

How do divorcing couples divide assets for tax purposes?
After you divorce is final, asset division and corresponding tax liabilities will be laid out in your settlement agreement. If you are filing taxes in the middle of the divorce process, however, asset division and taxes can be rather complex - especially for high asset couples. Here are some things to think about:

• If you are selling your home, mortgage and property deductions are typically divided equally. However, you may want to speak with your accountant about cost-basis issues.
• If you are buying out the equity in your home, the spouse that has bought the home is usually entitled to any mortgage and property tax deductions.
• If you will be liquidating a 401k or an IRA, keep in mind that income gained from the liquidation of such accounts is taxed (except Roth accounts). A Qualified Domestic Relations Order (QDRO) will allow you to divide retirement accounts and potentially avoid taxes if transferred to a qualified retirement plan within certain time restrictions.
• If you are in the middle of a divorce and not sure what to do regarding property division, consider filing jointly or simply dividing deductions equally.

TIP: Take a look at IRS Publications 503 & 504.
IRS Publications 503 and 504 are references for separated and divorced couples. Publication 503 covers child and dependent care expenses. Publication 504 is a general reference for a broad number of divorce issues including alimony, filing status, exemptions, etc. The publications can easily be found by google search.

Of course this only scratches the surface of the tax implications a divorce may have, and how they may influence the value of a settlement agreement. These are simply some of the more common concerns. It is critical that you hire a divorce lawyer to help you negotiate for the best agreement possible, and speak with an accountant about all of the tax concerns surrounding your divorce.

Modification of Alimony

As discussed in our general discussion on alimony, there are four distinct types of alimony in Mississippi. The type of alimony that was awarded or agreed to dictates whether or not a party may be able to modify alimony payment obligations down the line. Generally, permanent and rehabilitative alimony may be modified if there has been a "material change in circumstances" that affects either a payor's ability to pay alimony, or a recipient's need. However, lump sum alimony and reimbursement alimony (typically awarded as a lump sum) 'vest' when the award is made and may not be altered because of a change in circumstances.

The test for modification of alimony is virtually the same as the test for modification of child support - there must be a material change in circumstances that was not foreseeable at the time of the decree. The change in circumstances must be clear and substantial, but not every material change warrants a modification.

Just like most aspects of a divorce, modification will be determined by courts on a case-by-case basis, taking into account the specific facts and circumstances of each individual matter. Some general considerations to keep in mind:

• Alimony can not be awarded in a modification proceeding if the original decree did not provide for alimony
• Alimony may not be modified by an out-of-court agreement
• Only payments not yet due may be modified. Missed payments can not be modified or forgiven.
• Lifestyle choices are usually not reason for modification - new debt, and the births of later children generally do not constitute material changes

These are but a few of the things one must consider when evaluating whether or not a modification of alimony obligations may be warranted. If the financial situation of you or your former spouse has recently changed - whether from a promotion, a lost job, or any other significant change in income - you should speak with a divorce and family law attorney to see whether an alimony modification may be possible. Modification may be used to increase or decrease the support obligation depending on the change in circumstances.

Intro to Alimony

Alimony is probably one of the most complicated aspects of a Mississippi divorce. Chancellors have a lot of discretion in making alimony awards. Unlike child support, there are no statutory percentages to help guide judges or attorneys in determining the amount of an alimony award or agreement.

Since Mississippi adopted equitable distribution in 1994, alimony has become a secondary way to achieve financial equity between parties. First the court will divide the property, and if after distribution one party's assets and income are not sufficient to to meet reasonable expenses - the court may look to alimony to make up for the deficit.

In Mississippi there are four distinct types of alimony that can be awarded:

Permanent Alimony is an ongoing monthly support payment. It terminates at the death of either party - or if the party receiving the payment gets remarried. Permanent alimony may also be terminated upon the recipient's cohabitation (living with a new boyfriend or girlfriend).

Lump Sum Alimony is a fixed, certain amount that is vested at the time that the order is entered, even if paid in installments. It cannot be modified. It does not terminate at the payee's death or remarriage. It does not terminate at the payor's death, but survives as an obligation of the payor's estate.

Rehabilitative Alimony is designed to serve as temporary support for a spouse who may become employed after some training or job searching - it is assistance to help an individual in the process of becoming self-supporting. Courts have stated that the purpose of rehabilitative alimony is to avoid a spouse  becoming destitute in between divorce and reaching financial independence. Usually, rehabilitative alimony awards are shorter in duration - typically for no more than two or three years. Like permanent alimony, rehabilitative alimony terminates at the death of either the payor or payee. Unlike permanent alimony, rehabilitative alimony may not automatically terminate upon remarriage of the recipient party.

Reimbursement Alimony is the most recently developed type of alimony, having been created by the Mississippi Supreme Court in 1999. Reimbursement alimony is designed to repay one spouse that has supported the other through school before the couple has acquired any assets reflecting the educational investment. It is typically made in the form of a lump sum - and therefore is is not modifiable and does not terminate at the death or remarriage of either party.

Each alimony type has its benefits and its shortcomings. Working with a divorce lawyer to determine which type - or combination of types - of alimony will be in your best interest over the long term is of the utmost importance. Which type of alimony you are ultimately awarded or agree to will have a significant impact on your obligations down the road, and when or if you may be able to modify or terminate payments.