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Couples who are divorcing have several options for filing taxes. Neither spouse can file as single until the divorce is final. A joint return generally offers the lowest tax bracket, but each spouse is then liable for the other's tax liability. The "innocent spouse" provisions of tax law offer some protection to spouses who don't know about certain income, and some relief from the responsibility for the other's taxes.

One way to avoid responsibility for the spouse's tax liability is to choose the married filing separately status. However, tax rates are higher, several potential credits will be lost, and if one spouse itemizes, both must.

Couples who have children and don't live together in the last 6 months of the tax year have another option. The spouse who pays the majority of household costs for a home that is also the child's home for more than half the year can file as "head of household" (HOH). HOH offers several additional credits over married filing separately, and it lowers certain marginal tax rates. The HOH filer can take the standard deduction, which is higher than for married filing separately, even if the other spouse itemizes. The custodian parent is always entitled to the $2,900 dependency exemption for each child unless that parent specifically waives the right.

Qualified Domestic Relations Order

Retirement funds, such as IRAs, 401(k) plans, and Keoghs, are subject to division of property during divorce. However, withdrawing the funds early can bring penalties unless a Qualified Domestic Relations Order (QDRO) is obtained. The QDRO directs a retirement fund's administrator to pay a specific amount to a former spouse or child. Any payments made as a result of the order are exempt from early withdrawal penalties. The former spouse may defer tax on the payments by rolling them into an IRA within 60 days of receipt. Payments made to a child are taxed to the payer.

Property Transfers

The basis of property transferred in a divorce proceeding carries over from one spouse to the other. Therefore, it's important to consider not only the value of property received but also its tax basis. The recipient of appreciated property may pay tax on its inherent appreciation when it is later sold. The presence of this future liability should be recognized, quantified, and properly reflected in the divorce settlement.

Gift tax consequences can be avoided if the transfers are made under the terms of a written agreement between the spouses. A final decree of divorce must be obtained within a 3-year period beginning one year before the agreement is signed and ending 2 years thereafter.

Child Support & Alimony

Divorcing couples who wish to reduce their tax liabilities should consider reclassifying child support payments as alimony. Child support is excluded from the recipient's taxable income, and the payer cannot deduct it. Conversely, alimony is included in the recipient's taxable income, and the payer can deduct it.

If the alimony or support payer is in a higher tax bracket than the recipient, the money paid as child support will mean more taxes due than if paid as alimony. The payer may actually be able to make larger alimony payments and save both parties money. Special rules apply; in determining the alimony deduction.

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