Throughout your life there will be certain significant occasions that will impact not only your day-to-day living but also your taxes. Here are a few of those events:
Getting Married – If you just got married or are considering getting married, you need to be aware that once you are married you no longer file returns using the single status and generally will file as married taxpayers filing jointly (MFJ). When you file MFJ all of the income of both spouses is combined on one return, and where both spouses have substantial income, that could mean your combined incomes could put you in a higher tax bracket. However, when filing MFJ you also benefit by being able to claim a standard deduction equal to twice that of the standard deduction for a single taxpayer. It may be appropriate for a couple planning a wedding, or even those who just got married, to estimate differences of filing as unmarried and filing married so there are no unpleasant surprises at tax filing time. It may be appropriate to adjust withholding to compensate for the MFJ status.
Be mindful that filing status is determined on the last day of the tax year, so no matter when you get married during the year you will be considered married for the entire year for tax purposes. In addition, where a spouse is changing names the Social Security Administration should be notified, and the IRS should be informed of any address change by either or both spouses.
Buying a Home – Buying a home, especially your first home, can be a trying experience. Without a landlord to take care of repairs and upkeep of the property those tasks will become your responsibility as a home owner. When you rent, you are responsible for making a rental payment which is not tax deductible. On the other hand, when you own a home, in addition to being responsible for its maintenance, you have to make homeowner’s insurance, mortgage, and property tax payments. While the routine upkeep costs aren’t tax deductible, the interest on the mortgage and the property taxes you pay may be tax deductible, providing you with a significant saving in income tax. However, if the standard deduction amount for your filing status exceeds the total of all itemized deductions the law allows you to claim, you won’t get a tax benefit from the home mortgage interest and property tax payments. So, when figuring if you can afford a home be sure to take into account whether you’ll benefit from those home-related tax savings. Also consider the long-term benefits of home ownership. Homes have generally appreciated in value in the past, so you can look forward to your home gaining value, and when you sell it, the gain up to $250,000 ($500,000 for a married couple) can be excluded from income if the property has been owned and used as your primary residence for any 2 of the 5 years just prior to the sale.
Having or Adopting Children – Besides the loss of sleep, changing diapers, middle of the night feedings, and constant attention, a new born also brings some tax benefits, including a maximum $2,000 child tax credit which can go a long way in reducing your tax liability. If both spouses work, you will no doubt incur child care expenses which can result in a maximum (can be less) credit of between $600 and $1,050 for one child or twice those amounts for two or more children. The credit amounts are based on a maximum child care expense of $3,000 for one child and $6,000 for two or more multiplied by 20 to 35 percent of the expense based upon a taxpayer’s income.
Of course, the medical expenses are deductible if you itemize your deductions but only to the extent the medical expenses exceed 10% of your adjusted gross income. Although rarely encountered, the expense of a surrogate mother is not deductible.
If you adopt a child under age 18 or a person physically or mentally incapable of taking care of himself or herself, you may be eligible for a tax credit for qualified adoption expenses you paid. The credit, which is a maximum of $14,080 for 2019, is not refundable, but if the credit is more than your income tax, you can carry over the excess and have 5 years to use up the credit. If the child is a special needs child, the full credit limit will be allowed for the tax year in which the adoption becomes final, regardless of whether you had qualified adoption expenses. The credit phases out for higher income taxpayers.
It is also time to begin planning for the child’s future education. The tax code offers two tax favored education savings accounts, the Coverdell account allowing a maximum contribution of $2,000 per year and the Qualified State Tuition plan, more commonly referred to a Sec 529 plan, which allows large sums of money to be put aside for a child’s education. There is no tax deduction for contributing to either of these programs, but the earnings from the plans are tax-free if used for qualified education expenses, so the sooner the funds are contributed the greater the benefit from tax-free earnings.
Getting Divorced – If you are recently divorced or are contemplating divorce, you will have to deal with or plan for significant tax issues such as asset division, alimony, and tax-return filing status. If you have children, additional issues include child support; claiming of the children as dependents; the child, child care, and education tax credits; and perhaps even the earned-income tax credit. Here are some details:
- Filing Status – As mentioned earlier your filing status is based on your marital status at the end of the year. If, on December 31, you are in the process of divorcing but are not yet divorced, your options are to file jointly or to each submit a return as married filing separately. There is an exception to this rule if a couple has been separated for all of the last 6 months of the year, and if one taxpayer has paid more than half the cost of maintaining a household for a qualified child. In that situation then that spouse can use the more favorable head-of-household filing status. If each spouse meets the criteria for that exception, they can both file as heads of household; otherwise, the spouse who doesn’t qualify must have the status of married filing separately. If your divorce has been finalized and if you haven’t remarried, your filing status will be single or, if you meet the requirements, head of household.
- Child Support – Is support for the taxpayer’s children provided by the non-custodial parent to the custodial parent. It is not deductible by the one making the payments and is not income to the recipient parent.
- Children’s Dependency – When a court awards physical custody of a child to one parent, the tax law is very specific in awarding that child’s dependency to the parent who has physical custody, regardless of the amount of child support that the other parent provides. However, the custodial parent may release this dependency to the noncustodial parent by completing the appropriate IRS form.
- Child Tax Credit – A federal credit of $2,000 is allowed for each child under the age of 17. This credit goes to the parent who claims the child as a dependent. Up to $1,400 of the credit is refundable if the credit exceeds the tax liability. However, this credit phases out for high-income parents, beginning at $200,000 for single parents.
- Alimony – The recent tax reform also impacts the tax treatment of alimony. For divorce agreements that were finalized before the end of 2018, the recipient (payee) of the alimony must include that income for tax purposes. The payer in such cases is allowed to deduct the payments above the line (without itemizing deductions); this is technically referred to as an adjustment to gross income. The recipient who includes this alimony income can treat it as earned income for purposes of qualifying for an IRA contribution, thus allowing the recipient to contribute to an IRA even if he or she has no income from working. Get rid of bullet symbol for next paragraph For divorce agreements that are finalized after 2018, alimony is not deductible by the payer and is not taxable income for the recipient. Because the recipient isn’t reporting alimony income, he or she cannot treat it as earned income for the purposes of making an IRA contribution.
- Tuition Credit – If a child qualifies for either of two higher-education tax credits (the American Opportunity Tax Credit [AOTC] or the Lifetime Learning Credit), the credit goes to whoever claims the child as a dependent even if the other spouse or someone else is paying the tuition and other qualifying expenses.
Death of Spouse – Losing a spouse is difficult emotionally, and unfortunately, can be accompanied by a number of tax issues that may or not apply to the surviving spouse. Here is an overview of some of the more frequent issues:
- Filing Status – If a spouse passes away during the year, the surviving spouse can still file a joint return for that year if the surviving spouse has not remarried. However, after the year of death the surviving spouse will no longer be able to jointly file with the deceased spouse and will have to use a less favorable filing status.
- Notification – If the deceased spouse is receiving Social Security benefits the Social Security Administration must be immediately notified. This would also be true of pensions and retirement plans of the deceased spouse.
- Estate Tax – Where the deceased spouse’s assets and prior reportable gifts exceed the current lifetime inheritance exclusion ($11.4 million for 2019) an estate tax return may be required. However, the lifetime inheritance exclusion can be changed at the whim of Congress. Even when an estate tax return isn’t required because the value of the deceased spouse’s estate is less than the exclusion amount, it may be appropriate to file the estate tax return anyway, as there could be an impact on the estate tax of the surviving spouse when he or she passes.
- Inherited Basis – Under normal circumstances the beneficiary of a decedent’s assets will have a tax basis in those assets equal to the fair market value of the assets on the date of death. Thus, generally a qualified appraisal of the assets is required. However, for a surviving spouse this can be more complicated depending upon whether the state of residence is a community property state and how title to the property was held.
- Changing Titles – The title to all jointly held assets needs be changed into the survivor’s name alone to avoid complications in the future.
- Trust Income Tax Returns – Many couples have created living trusts that, while they are both alive, don’t require a separate tax return to be filed for the trust and can be revoked. But upon the death of one of the spouses, this trust may split into two trusts, one of which remains revocable and the other becomes irrevocable. A separate income tax return for the latter trust will usually have to be prepared and filed annually.
These are just a few of the issues that must be addressed upon the death of a spouse, and it may be appropriate to seek professional help.
If you have questions about the tax impact of any of your life changing situations, be sure to give our office a call for assistance.