May 1, 2017
Last September I wrote about issues related to the income tax return that can arise in a divorce. Some income or expense items that the couple share on their tax return will need to be divided or assigned to one or the other party once the divorce is final. I briefly mentioned two areas, estimated tax payments and tax refunds, that warrant more investigation.
Estimated Tax Payments: Jim and Heather are both self-employed. Because they don’t have taxes withheld from their income, they make estimated payments four times a year to the IRS. Their accountant has been advising them to base their payments on the amount of tax they owed in the previous year (a common strategy.) In 2017 the couple makes estimated tax payments in April and June, and then divorce in August. At that point the IRS considers them to be “single” filers. What should they do about the estimated payments they made together?
The textbook answer is simple: the IRS allows them to divide the payments in any manner they choose. If they can’t agree, then they should apportion the estimated payments according to how much tax each of them owes on their separate returns for the current year. The problem is that estimated payments are typically credited to the “first taxpayer” (the person listed first as “taxpayer” on the joint tax return.) Both must follow a procedure for notifying the IRS that the estimated payments are being divided (by statement on Form 1040, line 65). Problems will arise without this notification: if the “first taxpayer” files his or her tax return before the “second taxpayer” all of the estimated payment will be applied to that person’s tax return, leaving the second spouse high and dry. I recommend that couples discuss estimated tax payments during their divorce proceedings and decide how they will be divided so that there is no confusion at tax time.
Dividing Tax Refunds: Bob and Marcie received a big tax refund in 2016, about $5,000. They decided to apply it towards their 2017 taxes. However during 2017 they were divorced. Who should get to use this refund?
The IRS says the refund should be given to the person who gave rise to the overpayment. If both parties contributed, then the refund should be apportioned according to each spouse’s tax obligation in the current year.
Unfortunately, even when an agreement is made and some portion is given to the “second taxpayer” the IRS often applies all of it to the “first taxpayer.” Some tax advisors recommend compensating the “second taxpayer” for his or her portion of the refund and allowing the “first taxpayer” to receive the full amount. Tax refunds, like estimated tax payments, are a topic to address during a divorce.
Correction: In the April newsletter, I noted that the IRS qualifications for alimony included “remarriage or cohabitation.” These are not IRS requirements.
