Accounting On Us
The tax impact of having a family
Marriage, kids and divorce, oh my!
Tiffany McBride, CPA
There are many things to consider when getting married and starting a family. Maybe you’re arranging daycare or buying a new house. Are you also thinking about your taxes? It seems like an odd suggestion, but you should be. Whether you’re a newlywed, a new parent or you’ve been doing this for years, having a family impacts your tax picture. Here’s a breakdown of the items you should have on your radar to make sure you’re maximizing every tax savings opportunity.
One of the biggest ways marriage impacts your taxes is your filing status, which is determined by your marital status on December 31. So, if you get married on New Year’s Eve, for tax purposes, you are considered married for that whole year. You’ll also need to decide if you and your spouse will file jointly or separately.
Filing jointly, the marriage penalty and the marriage bonus. So, what about that marriage penalty I hear about in the news? Both the marriage penalty and the marriage bonus result from the change in a couple’s total tax bill as a result of getting married and filing their taxes jointly. Penalties are not really penalties but are an increase in tax when two people file jointly when married vs when two individuals file single. Penalties usually come when you two make about the same amount of money and typically only affect the higher income tax bracket individuals. Marriage penalties can be as high as 12% of a couple’s income.
Bonuses are a result of two people paying less taxes as a married couple that file jointly than if they remained single and filed as such. You get a marriage bonus when you have one high earner and one low or no earner. Marriage bonuses can be as high as 21% of a couple’s income.
Filing separately. There are several reasons you would want to consider filing separately instead of jointly:
- Significant itemized deductions limited by adjusted gross income
- Income driven repayment plans for student loans (to separate your tax liability from your spouse’s)
- Living in a community property state
- Distinct non-financial circumstances with your spouse
- Non-tax items such as a prenup or other legal documents
By filing separately, you lose a slew of tax breaks such as the tax-free exclusion of U.S. bond interest and Social Security benefits as well as the ability to make any Roth IRA contributions. You also wouldn’t be eligible for many tax credits and deductions, including the education credits, child and dependent care credit, net capital losses deduction and traditional IRA deductions, among others.
If you’re in Arizona, filing separately becomes even more complicated if you do not have a legal document to separate estates (ie prenup). Arizona is a community property state and would require one half of the spouses community income to be reported on the taxpayer’s married-filing-separate return. Remember, filing status is unique to each taxpayer, and is determined on the facts and circumstances of your life, so be sure to talk to your CPA about what’s best for your situation.
Thanks to tax reform, there’s no longer an exemption for dependents, which is a huge loss for many taxpayers; however, there are several credits you may still qualify for that provide tax savings.
Child tax credit. One of the biggest tax breaks available for claiming dependents is the child tax credit. You can receive a $2,000 credit for each qualifying child under the age of 17, and up to $1,400 of that is refundable. Now, if your dependents don’t meet the criteria, you may still be able to take the $500 credit for other dependents but take note – it’s not refundable. For example, if you are taking care of a parent and they qualify as your dependent you will be eligible for the $500 credit as well. The income threshold at which the credit begins to phase out has been increased to $200,000 or $400,000 if married filing joint.
Child and dependent care credit. Sometimes you may need help caring for your dependents. If you pay someone to care for your child under 13, disabled spouse or another disabled dependent so that you can work or look for work, the child and dependent care credit can help. The credit amount varies between 20% and 35% of your allowable expenses, up to $3000, and the percentage is based on your income. The credit is nonrefundable and can only reduce your tax liability. If you are married you will need to file jointly with your spouse to qualify and both spouses must be working, looking for work or attending school full time to qualify. To get the credit, you must provide the provider’s name, address and taxpayer identification number.
Adoption credit. If you are looking to expand your family through adoption there is a credit you may be eligible for. The federal adoption credit for 2019 is $14,080 and may be adjusted by the cost of living calculation. The credit starts to phase out if your modified adjusted income is more than $211,160 and is completely phased out at incomes above $251,160. The adoption credit can be very specific so we would suggest talking to a tax professional to insure you are getting the greatest benefit.
Education credits. If you have a child attending college, you may qualify for the American Opportunity or Lifetime Learning credits, which can help reduce your tax liability. Keep in mind, you cannot take both credits for the same student in the same tax year and there are income phase-outs.
Credits aren’t the only consideration when evaluating your family’s tax picture for saving and planning opportunities.
529 Plans. A 529 Plan is a great way to save tax and pay for your child’s education expenses. Earnings in a 529 plan grow federal-tax free and will not be taxed when the money is used to pay for college. Starting in 2018 up to $10,000 in distributions, per year, per beneficiary, from a 529 plan can be used to pay for tuition expenses for secondary school.
Kiddie tax rules. Tax reform made big changes to the kiddie tax rules, we do not need to finish the parent’s return before we finish the kid’s return now. Children are no longer subject to their parents’ tax rates. Instead, they’re taxed at the rates applicable to trusts and estates, which can cause a sizeable bill.
Going through a divorce is difficult enough without the added stress of making sure your tax situation is in order, but you definitely don’t want to let this slip through the cracks.
Filing status. Remember, your filing status is determined by your marriage status as of December 31. So, if you’re divorced on December 31, you would file single. If you’re still married, you will need to figure out if you will file jointly, separately or as head-of-household in certain circumstances.
Tax Carryforwards. You always want to be cognizant of any carryforwards and who gets allocated these, including the capital loss, passive loss and credit carryovers. Without an agreement in place, the carryover will be allocated under federal tax law according to legal title.
Dependents. If you’re divorced, only one of you can claim your children as dependents, so you’ll need to take into account who has custody of the kids. What happens if one party claims a child they’re not supposed to by filing first? You would paper file your return, claim your dependent and both of you will receive notices from the IRS to file support for claiming your dependency exemption.
Any time you experience a major life transition – marriage, divorce, a new baby, etc. – be sure to contact your Henry+Horne tax advisor who can assist with any necessary tax planning.
Tiffany McBride, CPA, Manager, specializes in estate, gift + trust taxation as well as tax planning and compliance for high net worth individuals. You can reach Tiffany at (480) 483-1170 or TiffanyM@hhcpa.com.