Divorce & Taxes Series: Part 1

The thought of taxes is stressful enough, let alone when divorce becomes a factor.  To help you sort through this wildly misunderstood area of divorce financial planning, I will be posting several “Tax Snippets” over the next several days.

These Tax Snippets are written based on my observations and experience.  I am and not a CPA, tax planner or tax attorney.  I am a mediator and former family law attorney.  These are, however, some of the key issues that I see over and over again with my clients.  This series of articles is intended to help you “get your feet wet” in this mucky area of divorce.  If you think any of these issues might affect you, see your tax professional for up-to-the-minute and personally tailored tax advice.

Tax Snippet #1 – Filing Status Your filing status is a defining factor in determining your tax bracket.  Tax status is dependent on (1) your marital status, and (2) your parenting arrangements (if you have dependent children).  The choices are, in order of preference for most people (i.e., greatest tax advantages):

  • Married Filing Jointly
  • Head of Household (see “Tax Snippet #4)
  • Single
  • Married Filing Separately

Determining – and often times actively choosing — your tax status is very important.  The percentage of tax that you pay to Uncle Sam on your Adjusted Gross Income1 — 10 to 35% (with some exceptions) — is determined by your tax bracket.

Your tax status is determined on December 31st of that tax year.  Period.  It has nothing to do with April 15 or any other factors.  In other words, if you are divorced on or before December 31, you only have the tax status choices that single people have (single, head of household).  You lose the tax advantages that “married filing jointly” might offer for that tax year.

Don’t panic, though, if you are still married on December 31, but your spouse refuses to file with you or, on the other hand, if you decide that you don’t want to file with him/her for your own reasons.  If you are the main residential caretaker of your child(ren), there may be a less expensive way to present yourself to the IRS than as a “married filing separate” or “single”.  The IRS calls this “Head of Household” status.

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1Definition of Adjusted Gross Income (AGI): Your AGI is your gross, or total, income from taxable sources minus certain deductions.  Income includes salary and other employment income, interest and dividends, and long- and short-term capital gains and losses.  Deductions include some unreimbursed business and medical expenses, contributions to a deductible individual retirement account (IRA), and alimony you pay.  Your AGI serves as the basis for calculating the income tax you owe.  (See page one of your federal tax return.) Your AGI is then used to establish your eligibility for certain tax or financial benefits, such as deduction of your IRA contribution or qualifying tax credits (such as the child tax credit and the earned income credit).

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Tax Snippet #2 – Tax Advantages for Parents Lots of divorcing people get confused when it comes to the tax benefits of having children.  That is because, when they were married and raising children under the same roof, the tax benefits allowed were clear.  Upon divorce, however, the rules get very confusing.  Some of the key tax benefits of having children become “negotiable” upon divorce.  It is important for you and your soon-to-be-ex to figure out how your tax reality and your parenting arrangements relate to and affect on another.  Here are the key points to consider:

(1) The Dependent Child Exemption (a deduction):  Every member of a household potentially counts toward a tax-deductible exemption on the family tax return.  In 2011, each exemption will equate to a $3,700 deduction.  So, if you are single and claim the exemptions for 2 kids, you have 3 exemptions totaling $11,100 in deductions.  Whether or not you may claim your child(ren) as a dependent for purposes of utilizing the exemption is a point of negotiation in divorce settlements.  The primary residence of the child(ren) does not necessarily have to determine who can claim the child(ren) on their federal tax returns and custodial parents can give away the right to claim the child(ren) as dependents by completing IRS Form 8332.  (See your CPA for up-to-the-minute details.)

(2) Other IRS Benefits to Parent Claiming Dependent Exemption(s):  The party who claims the child(ren) as a dependent on his/her tax return (whether by default or pursuant to agreement and the completion of IRS Form 8332) is also the only parent eligible for other IRS benefits including, but not limited to:

  • The Child Tax Credit:  $1,000 per child, under the age of 17, with gradually reduced phase-outs that start at the following income levels:   $55,000 for married couples filing separately, $75,000 for single and head of household filers and $110,000 for married couples filing jointly.  In the phase-out range, the child tax credit is reduced by $50 for each $1,000 of income above these threshold amounts.
  • Certain College and Educational Credits: In 2010, there were two tax credits that apply to education: The American Opportunity Credit (which replaced the Hope Credit) and the Lifetime Learning Credit.  The American Opportunity Credit is worth up to $2,500 for each qualifying student, and is available during the first four years of postsecondary education.  The credit is phased out for taxpayers with adjusted gross incomes (taxable income “AGI” ) starting at $60,000 for single filers and $120,000 for joint filers.  The Lifetime Learning Credit is 20% of the first $10,000 you paid for qualifying tuition and related expenses each year.  The maximum credit for 2010 was $2,000.  Unlike the American Opportunity Credit, there is no limit on the number of years that this credit can be claimed; however, it is subject to the same AGI income phase rules as the American Opportunity Credit.

(3) Tax Benefits to the Primary Custodian (only!), regardless of who claims the exemption(s):

  • The Child & Dependent Care Deduction: If you paid someone to care for a child or a dependent so you could work, you may be able to reduce your federal income tax by claiming the Credit for Child and Dependent Care expenses on your tax return.  This Credit is available to people who, in order to work or to look for work, have to pay for child care services for dependents under age 13.  The Credit is also available if you paid for the care of a spouse or a dependent of any age who is physically or mentally incapable of self-care.  This federal tax credit can be worth up to 20-35% percent of the cost of day care (depending on your Adjusted Gross Income).
  • The Exclusion for Dependent Care Benefits: If your employer provides dependent care benefits on a qualified plan, you may be able to exclude those benefits from your taxable income.
  • The Earned Income Credit: This is a refundable tax credit that is given to qualified, modest-income taxpayers who have at least one child living at home.  The credit begins to phase out at $21,420 for married taxpayers filing a joint return with children and completely phases out at $40,463 for one child, $45,295 for two children and $48,279 for three or more children.  For married taxpayers filing a joint return with no children, the credit begins to phase out at $12,470 and completely phases out at $18,440.
  • Right to File as “Head of Household”: Filing taxes as “Head of Household” is also wholly dependent on which parent is considered the “primary custodian”, and IRS Form 8332 has no affect on this privilege.  (See Tax Snippet # 4)

The thought of taxes is stressful enough, let alone when divorce becomes a factor.  To help you sort through this wildly misunderstood area of divorce financial planning, I will be posting several “Tax Snippets” over the next several days.

These Tax Snippets are written based on my observations and experience.  I am and not a CPA, tax planner or tax attorney.  I am a mediator and former family law attorney. These are, however,  some of the key issues that I see over and over again with my clients.  This series of articles is intended to help you “get your feet wet” in this mucky area of divorce.  If you think any of these issues might affect you, see your tax professional for up-to-the-minute and personally-tailored tax advice.

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