A few months back, I did a blog post on how marital status affects filing status. But the post did not explain how to file in the year of divorce.
I don’t do tax prep at our office, but I review a lot of tax returns in my business planning practice. In the past ten years I have seen my fair share of incorrect returns. One area that is almost always misunderstood and misreported is how to file in the year of divorce.
Texas is a community property state.
If you are going through a divorce, you have probably been told this at least half a dozen times. This means that all income earned during marriage is half yours and half your spouse’s. The name on the W-2 is not relevant.
The year of divorce is no different for community property income allocation. However, we have noticed that whenever that decree is signed, the ex-spouses catch marriage amnesia, they forget about the existence of their marriage and their tax filing obligations for the final year of marriage.
The tax rules are clear—the couple must report income as community income up until the date of divorce. For example, if Harry has income from his job of $100,000 in 2022 and Sally has $50,000 of income from her job in the same time period and they divorce on July 1, 2022, Harry must report $87,500 of income for his 2022 tax return ($25,000 his share of income prior to divorce + $50,000 his income after divorce + $12,500 his share of her income prior to divorce).
Sally would report $62,500 ($12,500 her share of income prior to divorce + $25,000 her income after divorce + $25,000 her share of his income prior to divorce). Note that in the year of divorce, both parties would either file as single or head of household (if the head of household rules are met).
There are some exceptions under Section 66 that allow a taxpayer to ignore the community property rules for income allocation of earned income, but absent an exception, this is the proper method to allocate income.
Do you anticipate any problems? Most ex-couples are not keen on sharing financial information (or even a phone conversation) after a divorce is finalized, but never-the-less, the tax rules mandate it. Many divorce attorneys believe that the proper vehicle to override federal tax law is the divorce decree.
Attorneys draft the decree with language such as “The parties shall file their return in the year of divorce as if they were divorced as of January 1 of that year.” In other words, the parties are agreeing to bypass community income allocation in the year of divorce. Some attorneys argue that drafting a formal “partition” agreement into the divorce decree will turn off the allocation in the year of divorce. I am not convinced this would be effective to the IRS. The IRS will generally respect partition agreements for a partition of community assets, but a partition agreement for income that has already been earned is a stretch.
Partition agreements and fancy lawyer language aside, many CPAs would argue with me that allocating income in this manner after a divorce is just not practical, so it is secretly ignored, forgotten, or buried…not unlike the wedding vows of a failed marriage. I get it, but the IRS may not.
If you need help navigating a divorce in Texas, give TLC Law a call at (903) 871-1714 to see if we can help with your case.