Although it may uncomfortable to contemplate the possibility of a divorce, you should understand how a divorce might affect your business and financial future.
All divorces involve a distribution of assets – and typically, the result of this distribution will likely be a significant decline in your economic status. Dividing up property, pensions, retirement accounts, and other assets can also be very complicated, and the rules vary from state to state.
Because of this complexity, I strongly recommend that you seek professional help from an attorney, a tax professional, and a financial planner who can represent your interests and make sure you get a fair deal in your divorce settlement.
Of course the emotional impact of a divorce can be extremely painful and may take years to heal. There are resources that can help you through this process, such as Womans Divorce, a site that is dedicated to “helping women survive divorce and rebuild their lives.”
In this article I will discuss:
* The effect of divorce on your future taxes
* The tax impact of selling your home
In Part II I will discuss:
* The impact of divorce on your Social Security and retirement benefits
* Whether your business should be considered an asset in your divorce settlement
The effect of divorce on your future taxes
Your tax filing status is based on your marital status as of December 31st. This means that you’ll file your first tax return as a single person or head of household in the tax year in which your divorce becomes final.
You’ll be able to claim all your normal business deductions as before; they won’t be affected by your filing status.
Many married child care providers have their husband withhold money from his paycheck to help cover their estimated taxes. If you have started divorce proceedings in the beginning or middle of the year, start filing your own estimated taxes (IRS Form 1040ES) to avoid paying penalties. Any money withheld by your husband will be credited to him when he files his separate tax return at the end of the year. The IRS will only give you credit for taxes filed under your name.
Therefore, in your divorce settlement, ask your spouse to cover part or all of your tax bill for the final year of your marriage. This includes federal and state income taxes, Social Security taxes, and any penalties you may owe for not paying estimated taxes quarterly. Of course, if you were paying estimated taxes and covered your spouse’s taxes, it would be reasonable for you to continue to pay his taxes in the last year of your marriage.
If your husband is self-employed and has been paying all of your family’s taxes through his own estimated tax payments, then you can claim part of these payments on your tax return for the final year of your marriage. For more information, see IRS Publication 504 Divorced or Separated Individuals.
The tax impact of selling your home
If you are awarded your home in the divorce settlement you should be aware of the tax liability you will face when you sell the home.
At that time, you will have to pay taxes on the amount of house depreciation that you were entitled to claim after May 1997. You’ll have to pay these taxes in the year you sell your home, regardless of whether or not you actually claimed this depreciation deduction. See my article “Will You Owe Taxes When You Sell Your Home?”
Let’s look at an example. You started doing child care in your home in 2005 and were entitled to claim $1,000 in house depreciation each year until 2014 when you were divorced. You stay in your home and eventually sell it in 2020. For the ten years you were married, you were entitled to claim $10,000 in house depreciation (2005-2014 = 10 years x $1,000 per year).
Let’s also say you were entitled to claim another $6,000 in house depreciation between 2014 and 2020. Therefore, you will owe taxes on $16,000 when you sell your home in 2020. The amount of tax you will owe on the $16,000 will depend on your tax bracket in 202o. The tax rate could be 10%, 15% or 25%. Therefore, you could owe $1,600, $2,400, or $4,000 in taxes in 2020.
Note: You will owe this tax even if you didn’t claim the $1,000 a year in house depreciation. The IRS rule clearly states that when you sell your home, you will be treated as if you did depreciate it! Therefore, you should always depreciate your home, no matter what!
Since you and your husband both received a tax benefit on the $10,000 of house depreciation deductions over 10 years, he should pay tax on half of this amount when the home is sold. In other words, he should pay either $500 ($5,000 x 10%), $750 ($5,000 x 15%) or $1,250 ($5,000 x 25%).
Your tax preparer can help you estimate the likely amount of your future tax bill, so you can calculate your husband’s share. Your attorney should negotiate this as part of your divorce settlement. I recommend getting payment from your husband at the time of the divorce, rather than waiting until you sell the home.
Tom Copeland – www.tomcopelandblog.com
Image credit: http://ronafischman.com/divorce-and-the-rising-real-estate-market/
For more information, see my book Family Child Care Money Management & Retirement Guide.