Module 8: Tax Implications in Divorce Financial Planning

Question 1

Elliott and Grace divorced in November 2018 after 24 years of marriage. In past years, they always filed a joint return. Elliott pays child support to Grace who has primary custody of their 16-year-old son (Trevor). Elliott lives alone and has no other dependents. For 2018, which of the following filing statuses does Grace qualify for that gives her the greatest tax benefit?

Answer 1

Head of Household

Grace qualifies as Head of Household because Trevor is her dependent.

Question 2

Elliott and Grace divorced in November 2018 after 24 years of marriage. In past years, they always filed a joint return. Elliott pays child support to Grace who has primary custody of their 16-year-old son (Trevor). Elliott lives alone and has no other dependents. For 2018, what filing status does Elliott qualify for that gives him the greatest tax benefit?

Answer 2

Single

Elliott only qualifies for Single status.

Question 3

Sherri has a tax-deferred annuity that will be transferred to John, her ex-husband, per the divorce decree. How is the transfer taxed and who will have to pay the tax?

Answer 3

John will pay ordinary income tax when he takes a distribution.

Question 4

How is marital status determined in the year the divorce takes place?

Answer 4

Marital status is based on the last day of the tax year.

December 31 is the measuring date for the year.

Question 5

Which payments are never taxable?

Answer 5

Child support

Question 6

How many years does the innocent spouse have to apply for relief under the innocent spouse rule?

Answer 6

Two years after collection activities have begun

An individual has two years until after the IRS has taken action to collect on the tax debt.

Question 7

Which of the following tax carryforwards affects the basis of an asset upon transfer in a divorce?

A) Capital loss
B) Passive activity loss
C) Investment interest expense
D) Net operating loss

Answer 7

B) Passive activity loss

Any passive activity loss carryforward is added to the basis of the asset transferred in a divorce. It would reduce the taxable gain when the asset is sold.

Question 8

Which method of transferring IRAs will never be subject to income tax and penalties?

Answer 8

Transfer the IRA assets to a new IRA in the name of the recipient spouse.

Question 9

Which of the following terms describes reporting certain deductions taken in a previous year as income?

A) Attribution
B) Recalculation
C) Recapture
D) Reclassifying

Answer 9

C) Recapture

Several provisions of the code provide for the “recapture” of tax benefits previously taken by the taxpayer through deductions, credits, or exclusions.

Question 10

Which parent is entitled to take the childcare credit?

Answer 10

The custodial parent claims the credit for the expenses he or she paid.

Question 11

Which Internal Revenue Code sections permits spouses or former spouses to transfer property tax-free?

Answer 11

IRC §1041

IRC §1041 permits tax-free transfers to spouses or ex-spouses if all requirements are met.

Question 12

Marty, age 48, is to receive half of Cindy’s 401(k) account in their divorce. He decides to have the plan administrator transfer his share to an IRA in his name. Before the transfer he takes out $10,000 pursuant to the 72(t)(2)(C) provision. What is the tax consequence of the $10,000 distribution?

Answer 12

He will only have to pay tax.

Marty took the distribution before he transferred his share of the 401(k) and qualifies for the penalty exception.

Question 13

Which tax credit is refundable?

A) Regular child tax credit
B) Earned income credit
C) Child and dependent care expenses credit
D) Retirement savings contribution credit

Answer 13

B) Earned income credit

The earned income tax credit is refundable. The credit is paid even if all of the taxes that were withheld are refunded to the taxpayer. There is a lot of fraud involving the earned income credit.

Question 14

Which of the following would disqualify a taxpayer from filing as Head of Household?

A) Having a child who qualifies as the taxpayer’s dependent
B) Paying more than half of the costs to maintain the household
C) Being not married (or considered not married) at the end of the year
D) Having a child who lives with the spouse more than half of the year

Answer 14

D) Having a child who lives with the spouse more than half of the year

The child has to live with the person who is filing as Head of Household for more than half of the year.

Question 15

Which of the following tax carryforwards does not have a rule for allocation between spouses?

A) Net operating loss
B) Charitable contributions
C) Capital losses
D) Alternative minimum tax credit

Answer 15

D) Alternative minimum tax credit

There is no rule for allocating alternative minimum tax credit. The other options all have a rule for allocation.

Question 16

Capital Loss Carryforward

Answer 16

When a joint couple had capital loss carryovers and the following year they file as separate individuals, each individual carries forward the amount of loss that arose from items they individually owned. If the properties generating the losses were jointly owned or treated as such in a community property state, the loss carryforwards would be split equally between the spouses.

Question 17

Charitable Contributions Carryforward

Answer 17

A joint contribution carryforward is apportioned between spouses in the ratio of what their separate carryforwards would have been had they filed separately for the year in which the excess contribution arose.

Question 18

Suspended Passive Activity Losses

Answer 18

Suspended passive activity losses (PALs) do not carry over to the recipient. In the eyes of the IRS, since property a spouse receives due to a divorce is treated as a gift, suspended losses are added to the basis of the activity immediately before the transfer to the donee. Thus, the recipient’s deduction of the suspended passive loss is deferred until the property is sold.

Question 19

S Corporation Losses

Answer 19

Transfers or exchanges to a spouse or former spouse incident to a divorce are generally tax free. When a tax-free transfer of S Corporation stock occurs, the spouse who gets the stock also gets any carryover of disallowed losses or deductions.

Question 20

Investment Interest Expense Carryforwards

Answer 20

The deduction for investment interest expense is limited for individuals by the amount of their investment income. If their investment expense is greater than their income, the excess is carried forward indefinitely. Since the computation for net investment income is different for regular and alternative minimum tax, individuals will most likely have different carryforwards between the two.

There is currently no administrative or judicial authority on how to allocate these carryforwards, leading to the presumption that any reasonable method could be used. In community property states, the reasonable method would likely be a 50/50 split.

Question 21

Net Operating Loss (NOL) Carryforwards

Answer 21

NOL carryovers follow the individual who generated the NOL. If a joint return was filed that produced an NOL and the following year separate returns are filed due to divorce, the taxpayers must look back at the joint return to see whose losses generated the NOL. If the NOL was generated by each spouse, the carryover must be allocated between the spouses in the ratio of what the separate NOL carryforwards would have been if each spouse separately computed income and deductions. If taxpayers are in a community property state, the NOL again will most likely be split 50/50.