Who Gets to Claim the Children on Taxes?

In a custody case, one of the issues involved in many negotiations is who will get to claim the children as dependents on their income tax returns.  This is called the dependency exemption.  Children can be quite valuable when it comes to filing taxes and how much a person will owe or receive back as a refund.  Many clients, especially lower income clients who receive the Earned Income Tax Credit can receive thousands of dollars back which is more than several months of income from their job.South Carolina Family Courts have the authority to determine which parent gets to claim the children on the income tax return (SC Code Ann. §20-3-130(F)); however, the Court will not be able to allocate or distribute this exemption unless it is specifically asked for or allowed to be tried as an issue without objection from both parties.Typically, the custodial parent will be awarded the dependency exemption; however, if the non-custodial parent is allowed to claim the dependency exemption for one or all of the children, the custodial parent will be required to complete and execute IRS Form 8332 each year and that form must be included with the non-custodial parent's tax return when he/she files it.But what if you don't have a court order - before anyone has filed for custody?  The IRS has a five part test for determining which parent may claim the dependency exemption:

1. Relationship;
2. Age;
3. Residency;
4. Support;
5. Joint Return.

The Relationship test means that the dependent you are claiming is your son or daughter (natural or adopted), a foster child, brother, sister, half-brother, half-sister, or a descendent of any of them.The Age test simply means that your child is under age 19 at the end of the year and younger than you (or your spouse) or they are a student under the age of 24 at the end of the year and younger than you or your spouse.  Finally, regardless of age, you may claim a child if they are permanently and totally disabled.To meet the requirements of the Residency test, your child must have lived with you for more than half the year. There are some exceptions for temporary absences such as illness, education, military service, or vacation.The Support Test requires that you provided at least one-half of your child's support for the year and the child did not provide more than one-half of his/her support for the year.  Most of the time this is not an issue; however, if your child works and earns enough income to support himself/herself, then you may lose this credit.The Joint Return test means that the child cannot file a joint return for the year.

Tie Breakers

Absent a Family Court Order outlining who can claim the children, it is entirely possible that both parents would qualify to claim the child as a qualifying dependent using the dependency exemption.  So who would get to claim the child in that case?

• If the parents do not file a joint return together but both parents claim the child as a qualifying child, the IRS will treat the child as the qualifying child of the parent with whom the child lived for the longer period of time during the year. If the child lived with each parent for the same amount of time, the IRS will treat the child as the qualifying child of the parent who had the higher adjusted gross income (AGI) for the year.
• If no parent can claim the child as a qualifying child, the child is treated as the qualifying child of the person who had the highest AGI for the year.
• If a parent can claim the child as a qualifying child but no parent does so claim the child, the child is treated as the qualifying child of the person who had the highest AGI for the year, but only if that person's AGI is higher than the highest AGI of any of the child's parents who can claim the child. If the child's parents file a joint return with each other, this rule can be applied by dividing the parents' combined AGI equally between the parents.

How to File Your Taxes

It's January and you're starting to get your W-2's, 1099's and other tax documents in the mail and you're ready to file your taxes.  You may have been through a divorce in 2012, contemplating divorce, or you may have received a final decree of separate support and maintenance but haven't been divorced yet.  The question comes up often about what filing status you should use when you prepare your tax returns: married filing jointly, married filing separately, head of household or single.There is often a benefit to filing married filing jointly or as head of household rather than filing married filing separately or single.  I'm sure people file with the incorrect status every year so they can get a larger refund or have to pay less in taxes.  Here's how to figure out the status you should file:

You filed for divorce in 2012 but the divorce has not been finalized and there is no final order of separate maintenance.

Since you are still married and there has been no action for separate support and maintenance filed, your options for filing status will be limited to married filing jointly or married filing separately.

A Final Order of Separate Support and Maintenance was entered in 2012

Since you have been issued a final order of separate support and maintenance you are still married, so you have the option to file married filing jointly, married filing separately, or head of household if you meet the additional requirements for that filing status.

You were divorced in 2012

Your marital status on December 31 is the determining factor for your tax filing status for that year.  Even if you were married the majority of the year, but you were divorced sometime in 2012, you must file either single or head of household (if you meet the additional requirements).

Time Magazine: Divorce and Taxes

The TaxGirl, Kelly Phillips Erb wrote a piece at TIME.com about divorce and taxes.  While tax day just passed us by last week, it's an interesting piece and answers many questions that I often receive from clients.Here's a sneak peek at the 5 points in the article:

1. Filing Status is based on the Calendar - not the date of your divorce decree.  Basically, if you are divorced between January 1 and April 15, but you were married on December 31, you will be filing as "married" (either jointly or separately).  But, if you get divorced in December you can't file as married, but you have the option of filing head of household (if you qualify) which could be beneficial.
2. If you are awarded the marital home in the divorce you could be responsible for capital gains taxes when it is sold since you don't have the joint marital capital gains wiggle room.
3. Just because you have the kids for equal time during the year doesn't make them your dependents for filing purposes.
4. Alimony is tax deductible for the paying spouse and it is deductible even if you do not itemize your deductions each year.
5. Child support is always tax neutral so no one gets a deduction or pays taxes for child support.

Check out the entire article here: Divorce and Taxes: Five Things You Need to Know

Are Your Lottery Winnings Getting Separted in the Divorce?

The Background

Imagine being separated from your spouse for several years. When you were together, you didn’t really have any property or debts. You didn’t have a lot of money in general. You left because you were tired of being abused and so you could protect your children. Since you separated, it has been a nightmare to try to collect child support. Your spouse rarely pays, and when he/she does, it isn’t on time. Since money is tight and divorce is expensive, you decided not to proceed with a divorce until you really needed to.Then, you hit the lottery. Literally. You are the new overnight millionaire. You and your children’s lives just got a whole lot better. And now, because of the notoriety and because of the money, you’re not just hearing from those long lost family members who would like a “loan” but your old flame just wandered back into the picture, and sent you a message, “you’ll be hearing from my lawyer.”What?!? Is he/she entitled to some of my lottery winnings? You may have heard about this situation recently on the morning shows. This is basically the facts of a real life case out in Utah where Holly Lahti won one-half of the Mega Million $380 million jackpot. She cashed in and took the lump sum payment of $80.6 million. There is some question about what percentage, if any, of the payout that her estranged husband would be entitled to since she never filed for divorce or legal separation. Let’s say that rather than being in Utah that this was going on in South Carolina. What would happen?

South Carolina Equitable Division

SC Code §20-3-630 defines marital property as "all real and personal property which has been acquired by the parties during the marriage and which is owned as of the date of filing or commencement of marital litigation ... regardless of how legal title is held."  So, since no divorce action or separate support and maintenance action had been filed by either party prior to Ms. Lahti winning the lottery, the lottery winnings would be considered "marital" and would therefore be subject to potential division by the court in subsequent divorce action.Since the property is subject to potential division, it would fall to several factors contained in SC Code §20-3-620 which gives the Court direction on how to apportion the marital property.  Potential relevant factors in this case would include marital misconduct or fault of one of the spouses (since Ms. Lahti's husband was allegedly abusive during the marriage which is a ground for divorce in South Carolina), the contribution of each spouse to the acquisition of the property, and finally a "catch all" that let's the judge consider other "relevant factors".I don't know exactly what a South Carolina Family Court Judge would do in this situation, but I think based on the abusive marriage and the time the parties have been separated (and that neither was relying on the other financially in any way) that very little of the lottery winnings (if any) would be apportioned to the husband.  Sorry dude!

Reporting Alimony Received on Income Taxes

Alimony is a tricky issue in a divorce case.  Many people want it (or don't want to pay it) but the tax implications of alimony are important to note and consider in the negotiation of your divorce settlement.  In general, alimony is taxable income to the recipient and is a deduction for the payor.The Tax Girl, Kelly Phillips Erb, recently answered a question on her tax blog about claiming alimony on your income tax return.  It's a quick and short read, but provides some good guidance on the importance of claiming alimony received on your income tax return even if that is the only income you had for the year.

Backing up Financial Information Before You Go

If you are contemplating leaving your marriage you may consider taking a few steps before breaking the news to your spouse or leaving the house to make sure you protect yourself and your financial interests.  South Carolina family courts are courts of equity when it comes to dividing up marital assets.  But before you can divide up assets and debts you must be able to identify all of those assets debts and determine which portion of them are marital and non-marital.  You may find that once you break the news to your spouse about the impending divorce communication may break down and walls of protection may go up around both of you.  Before that happens you should attempt to gather as much information about your family finances as possible.  Here are some tips:

1. Gather copies of tax returns;
2. Gather copies of financial statements;
3. Gather copies of insurance policies (whether they are term or whole life policies with a cash value and if they have a cash value, what it currently is).
4. Inventories of property in the house - using a video camera to record a walk-through of the house is a great way to do this to make sure you don't forget anything.
5. Inventories of property in safe-deposit boxes (though you should take a witness with you to (1) verify what is in there when you went and (2) verify that you did not remove anything from the box)
6. Retirement account statements.
7. Appraisals of real estate and personal property like jewelry, art, etc.
8. Copies of paystubs for you and your spouse for the year-to-date

Of course all of this information can theoretically be gathered in the discovery phase of your divorce litigation you can save a lot of time and a lot of money (on attorney fees) by having all of this information pulled together from the beginning.  Not only will you save yourself money on attorney fees, but you put yourself and your attorney in a better position when it comes to negotiating prior to and arguing at a temporary hearing.Another thing that will come of this information is that the more your specific knowledge your attorney has about your case the better he/she will be able to advise you about the likely outcomes or the best courses of action for you with less assumption.Hat tip to the Ohio Family Law Blog for the tips in this post from their post 12 Proactive Steps to Take If You are Contemplating Divorce.

Filing Bankruptcy Can Improve Your Family Life

Parenting and stress go hand-in-hand. Mix in being buried in debt, and the financial pressures can begin taking a toll on your family, your health, and your emotional well-being.Going through tough financial times increases tension within the family and interferes with your relationship with your children and your spouse. Don’t let the situation make you feel cut off from your family.Parenting is all about teaching your children. Share financial issues with your children much as you can, depending on their age. Opening up the lines of communication will not only keep you connected to them, but may also provide an opportunity to teach them about finances.When you first realize you are in over your head and can’t make your payments, contact your creditors and try to negotiate repayment plans with you.  Unfortunately, this is easier said than done.If you can’t restructure your debts, you should explore bankruptcy to relieve your financial stress.  Bankruptcy was designed to help individuals stabilize their finances and get out from under their financial burden by protecting their property, lowering their stress levels, and allowing them to sleep at night.Keep in mind that filing bankruptcy is not the problem. The problem is not being able to pay your bills and not being able to provide for your family. This financial pressure causes the stress and anxiety to build. All this spills over into your family relationships.To decide whether bankruptcy is right for you, contact an experienced bankruptcy lawyer who can help you navigate the complicated bankruptcy process and advise you about whether Chapter 7 (“straight bankruptcy”) or Chapter 13 (“reorganization bankruptcy”) is best for you.Once you have gone through the bankruptcy process, rejoice in new beginnings. You went through bankruptcy to get to a fresh start. Now, begin by developing a sound financial plan that will protect your finances and your sanity. Establish a savings plan that will allow you to better absorb financial strain and plan for your family’s future. Once your present situation is under control, you can begin to look to the future and set aside money for your financial goals.But What If I’m Getting a Divorce? Sometimes divorce is inevitable.  I practiced family law for ten years, so I know that debt not only can cause divorce but can also cause divorce proceedings to be more difficult than they would otherwise be.She says he spent too much.  He says she spent too much.  And neither can afford the credit card payments.  The divorce case can come to standstill over debt.If that’s the case, both spouses should consider bankruptcy.  Getting rid of debt means one less thing to fight over, and that’s a good thing for your divorce case.If you are married, you can file a joint bankruptcy case with your spouse.  Depending on your situation, you may even be able to use the same bankruptcy lawyer to do this.  Much hinges on whether there is any conflict of interest in having the same attorney represent you in your bankruptcy case—and that depends on the facts of your case.By using bankruptcy to get your financial house in order, you can reduce your stress, enjoy time with your family, and free up your mind to start planning for your future.Russell A. DeMott is a Charleston, South Carolina bankruptcy lawyer.