Nichols, Sacks, Slank, Sendelbach & Buiteweg, P.C. are not tax attorneys and are not qualified to give definitive tax advice. We have included information from the Internal Revenue Service website but suggest you review any information here with a qualified tax preparer prior to relying on it.
Divorcing couples should consider the tax ramifications of:
Click on the terms above for more information.
Filing Status and Exemptions
A divorced or divorcing couple’s filing status is determined as of the last day of a tax year, usually December 31.
Personal Exemption. In 2008, the personal exemption is $3,500 for a parent and each child. A dependency exemption reduces taxable income by a specific dollar amount, which, multiplied by the parent’s tax rate, equals a tax savings. The tax savings depends on your tax bracket.
Dependent Exemptions. Available if a minor child resides with you more than half time or the primary parent has waived it to the non-primary parent. For adult dependent children, the test is whether you provide more than half of the support for the child. Check the IRS website at http://www.irs.gov/formspubs/ for details about dependent exemptions for college age dependents and other dependency issues.
For example, if the exempt amount is $3,500 and the tax bracket is 30%, tax savings are $950. But if the parent’s tax rate is 15%, the savings are $525. In this case, the exemption is worth nearly twice as much to the parent in the higher tax bracket.
|If the tax rate is:||You could save, for each exemption:|
However, high-income earners begin to see a phase out of this benefit above certain levels. To calculate a partial phase-out for a personal exemption, see IRS Pub. 501
The Economic Growth and Tax Relief Reconciliation Act of 2001 gradually eliminates the phase- out rule over five years, beginning in 2006, phasing out by one-third in 2006 and 2007, then by two-thirds in 2008 and 2009, and will be gone in 2010. It really is a way to have people pay higher taxes without saying so and is essentially a tax only on high wage earning parents, not all high incomes.
Spousal support is treated very differently from child support with respect to taxation. Spousal support is treated as income to the receiving spouse, and deducted from the income of the paying spouse.
These requirements apply whether the spouses enter a private settlement agreement that becomes an order of the court (contractual spousal support) or the court orders spousal support after a contested trial (statutory spousal support).
Viz a viz property settlement. There are sophisticated ways to transform what would otherwise be a property settlement into a tax deductible/includable form of spousal support. This can only be done by the agreement of the parties; the court cannot order it. Such agreements must be very carefully structured to avoid costly pitfalls. If you and your spouse reach such an agreement, your attorney may recommend consultation with an accountant who is familiar with these rules to help negotiate and draft a careful plan.
Dependent Child Tax Concerns
Dependent Exemption. Generally, the parent who has custody for the greater portion of the year may claim the child as a dependent, providing that both parents together provided more than 50% of the child’s support. Custody for purposes of claiming a dependency exemption is first determined by the divorce decree. If the divorce decree does not specify who should be the custodial parent, the parent who has the actual physical custody of the child for the greater portion of the year may claim a dependency exemption.
Only the parent claiming the exemption can claim The Child Tax Credit. To qualify, the child must be under 17 at the end of the tax year. It is available to single or head of household taxpayers with income below $75,000. The maximum benefit is $1,000 per child. This too begins to phase out for higher income taxpayers. It usually does not result in a net refund (i.e. it can only reduce the tax to zero). However, for very low-income parents (no regular tax or when the Child Tax Credit exceeds the regular tax liability), the parent might qualify for a refundable Additional Child Tax Credit, essentially providing a tax refund. See http://www.irs.gov/newsroom/article/0,,id=106182,00.html.
Credit for Child and Dependent Care Expenses. If you paid someone to care for a child under age 13 so you could work or look for work, you may be able to reduce your tax by claiming the Child and Dependent Care Credit on your federal income tax return. To qualify, your child must be your dependent (See dependent exemptions, above). The credit is a percentage of the amount of work-related child and dependent care expenses you paid to a care provider. The credit can be up to 35 percent of your qualifying expenses, depending upon your income. For 2007, the taxpayer could use up to $3,000 of the expenses paid in a year for one qualifying individual, or $6,000 for two or more qualifying individuals.
These dollar limits must be reduced by the amount of any dependent care benefits provided by an employer that are excluded from income, such as an employer “cafeteria plan” that includes pre-tax set asides for health care or child care. See http://www.irs.gov/newsroom/article/0,,id=106189,00.html.
For those with “cafeteria plans” at work or qualified fringe benefit plans with childcare options, up to $5,000 of income can be received tax free for childcare expenses. At the highest tax brackets, this can result in a tax savings of $1,955. You cannot use this benefitand take the Credit for Child and Dependent Care.
The Hope Credit and the Lifetime Learning Credit. Two tax credits can help you offset the costs of higher education by reducing your income tax: the Hope credit and the lifetime learning credit, also referred to as education credits.
These credits may be taken on the tax return of the person claiming the student as a dependent exemption, whether the expenses were paid by the student or by one or both parents. The benefits are phased out at $47,000 to $57,000 of income for a single taxpayer or $94,000 to $114,000 for married joint filers. You cannot claim a Hope credit if your Modified Adjusted Gross Income (MAGI) is $57,000 or more ($114,000 or more if you file a joint return).
The Hope Credit is good for a credit against your taxes of up to $1,568 (indexed annually for cost of living changes) for the first two years of post-high school education. The Lifetime Learning Credit is worth up to $2,000 per return for costs beyond the first two years. The credits are not available if expenses are paid with tax fee money such as public assistance or tax-free educational savings.
For more information, refer to Form 8863 (PDF), Education Credit (Hope and Lifetime Learning Credits), Publication 970, Tax Benefits for Education, or Tax Topic 605, Education Credits. http://www.irs.gov/publications/p970.
Earned Income Credit. The Earned Income Tax Credit (EITC), sometimes called the Earned Income Credit (EIC), is a refundable federal income tax credit for low-income working individuals and families. Congress originally approved the tax credit legislation in 1975 in part to offset the burden of social security taxes and to provide an incentive to work. When the EITC exceeds the amount of taxes owed, it results in a tax refund to those who claim and qualify for the credit.
The rules are complex. You must have earned income, which does not include spousal or child support. A qualifying child need not be your dependent. If you have low income from any source and there is a qualifying child living with you, it may be worth asking a tax advisor or CPA to look at whether there could be a “win-win” for both parents where one parent may make use of the EITC and the other of the dependency exemption and Child Tax Credit, especially where the low wage earning parent cannot make full beneficial use of all three. So much for “simplified” tax forms! In 2008, MAGI for the credit is about $35,000.
Certain U.S. Savings Bonds can be used to pay for college expenses and exclude from taxable income. However, this benefit is only available to the person claiming the dependent exemption.
Negotiating Dependent Exemptions
A Qualified Domestic Relations Order (QDRO) is a court order that assigns the benefits of a qualified retirement plan to a nonemployee alternate payee. A plan administrator is required to determine if an order meets QDRO requirements within a reasonable period of time after the receipt of the order and must notify the spouses and any alternate payee of that determination.
Among the tax consequences of QDRO payments are: