Rules of disengagement: navigating the turbulent waters of divorce taxation.

• Author: Brautigam, Beverly

The tax consequences of divorce can be critical. Since it is the unusual divorce attorney who understands the intricacies of federal and California income tax laws, CPAs are well-suited to help clients structure their divorce settlements to be in compliance with state and federal laws.

Beyond compliance, CPAs help clients structure their settlements to pay the least amount of tax and result in the least amount of difficulty in tax return preparation. This involves reviewing their clients' marital settlement agreements for any tax consequences and explaining to them--and to their attorneys--any differences between the actual tax consequences and those stated in the agreement.

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The following is an overview of the most pressing issues CPAs need to know about when delving into the world of divorce taxation.

FILING A JOINT RETURN

If married on the last day of the year, the parties have the option of filing a joint return or married filing separately. There also might be the possibility of one, or both, of the spouses qualifying as head of household. To qualify as such, they must be separated for more than half the year and provide a principal abode for a qualifying child.

Often, two married filing separate returns result in more income tax due than on a joint return. The joint and several liability for the tax (on a joint return) should be considered.

If there is other than a joint return for the year in which separation occurred, care must be taken to determine who reports what income and withholding. Absent a prenuptial agreement to the contrary, earned income is community until separation, reportable fifty-fifty by each spouse, and earned income after separation is the separate income of the spouse who earned it. Keep in mind that self-employment tax is assessed without regard to community-property laws.

For example: Wife earned $70,000 of self-employment income, consisting of $20,000 of community income. Husband would report $10,000 of ordinary income not subject to self-employment (SE) tax and wife would report $60,000 of ordinary income, but $70,000 would be on her SE form.

Also income from a community-property asset is reported fifty-fifty until the asset is awarded to one spouse.

For example: The parties' rental property generated $10,000 of taxable income for the year in which they separated July 1. Their marital settlement agreement was signed March 1 of the following year and the rental property was awarded to husband. The agreement did not state an effective date of the division of the rental property, so they would each report $5,000 of taxable income in the year of separation and would each report half of the taxable income the next year through March 1. Husband would report the balance of the income received after March 1.

If withholding, estimated income tax payments or the overpayment from the prior year applied to this year is going to be claimed by a spouse whose social security number it is not under, be sure to write to the IRS and FTB and have them apportion the taxes between the spouses prior to filing the tax returns. Both spouses should sign these letters of instruction. The...