Marla Holly Conner
Common Life Events that Affect Taxes
What Major Life Events will affect my Finances and Taxes?
The biggest changes in your life usually mean a significant change in your finances and filing your tax returns. Some life changes are planned, and others are not. Many changes have significant effects on your tax bill. You have to play by the government's rules no matter what, so it helps to understand what these are to avoid a shock come tax time. On one level, these things impact emotions and perspectives. They also affect our finances by creating tax burdens. Knowing how these occurrences might impact your taxes or finances can help you handle major life events when then happen.
Changing your relationship status is one major life change that affects your taxes. If you get married, some tax savings may result from the union. Couples who file a joint return get a standard deduction that's twice as high as the standard deduction. Married couples can file separately but this isn't usually smart because you cannot claim some tax credits when you file separately. Even if you got married on the last day of the year, the IRS will still consider your tax situation as if you were married the entire year.
The downside to this filing status is that the IRS holds both of you responsible if your taxes are incorrect, so if your spouse is hiding income from the government, the IRS can come after you both. It can make sense if you don't want to be held responsible for the accuracy of your spouse's tax return. Or if one of you has a student loan with a payment plan that depends on the adjusted gross income (AGI), filing separately may help keep the person's payments low. while filing jointly could raise monthly payment requirements significantly.
Divorce is usually challenging from a personal and tax perspective. If you're divorced by December 31st of the tax year you're filing for, you must file as single. Filing single brings lower standard deductions and less favorable tax brackets, unless you have primary custody of a child, in which case you can file as head of household. Filing head of household gets a standard deduction between what married couples filing joint and single filers get. For couples with joint custody of children, the parent who has the children the most days of the year can claim head of household, while the other parent must file as single unless remarried. If an argument exists between who claims the child or children, the IRS will look for Form 8332 from the non-custodial parent.
You cannot write off child support or alimony payments that you paid to your ex. There is an exception for alimony payments if your divorce was finalized before 2019. If you were receiving alimony and you were divorced before 2019, you must claim this as income on your taxes, though child support you received or paid does not count.
Birth of a Child
Children change everything in so many ways, including your lifestyle and your budget. Your taxes evolve too. Having a child brings a lot more expenses, but it can also open the door to some valuable tax credits. Each child results in an additional child tax credit. Other benefits include the Earned Income Tax Credit, 529 plans, credit for dependent care costs, and credits for education. To qualify for these types of credits, children must meet certain criteria. (Ask Tax C.A.T.S. how). In order to start leveraging these tax benefits, each child will need a tax identification number or social security number.
The costs associated with school can pay dividends in terms of job opportunities and career enhancement, it can also result in tax benefits. The American Hope Opportunity Credit with a maximum amount of $2.500 and the Lifetime Learning Credit with a maximum amount of $2.000 can help offset your qualifying educational expenses. If you're paying off a student loan, you can deduct up to $2.500 of your interest on your taxes. The cost to obtain certain professional certifications or designations can also be written off on your taxes. After 2017, only the self-employed can take these types of expenses when they qualify as a business deduction.
Job Change, Job Loss, or Promotion
There are many types of job changes that affect your taxes. They include promotions, job losses, or the launch of a small business. Promotions bring more money, which is great new, but they can also mean a larger tax bill. If a promotion pushes you into a higher tax bracket, you'll lose more of your income to the government, but there are ways around this issue. It might be a good idea to adjust your W-4 withholdings or stash money in tax-deferred retirement savings or in a health savings account (HSA). Contributions to these accounts will reduce your taxable income and keep you in your lower tax bracket while still enabling you to reap the benefits of your new, larger income.
If you lose your job, you may find you get a large tax refund if you've been employed throughout the year and had the proper withholding in place. Know that if you get unemployment benefits from the government, that is considered taxable income. If you have a working spouse, you may need to adjust their income tax withholding to help. Also, know that job-hunting expenses may be deductible. If you stated a side-gig or gave up your traditional job to start a business, you'll need to think about the impact of this change on your taxes. With side-gigs, you typically et earned income, which isn't taxed when you received it. You'll need to put money aside for estimated tax payments and keep detailed expense records for potential itemized deductions.
Retirement Contributions and Distributions
Contributing to a tax-advantage account such as a 401K plan or individual retirement account can get you rewarding tax deductions, and generally the more you put in the better. However, once you start taking money out of your plan, expect to be taxed on that distribution. If you're like many Americans, you probably created a retirement account some years back which you've been contributing to for years. When you start taking retirement account disbursements, you'll need to think about the taxes on that money. At the same time, you're no longer earning the income that upped your tax burden, so taxation on disbursements may be nominal. Just know that if you start taking social security benefits, some of that money is also taxable. As such, plan your budget carefully so you take small disbursements that provide for the cost of living during your retirement.
Buying or Selling a Home or Rental Home, or Vacation Home
Buying or selling a home, rental home, or vacation home triggers some tax changes. When you buy a home, rental home, or vacation home, you can deduct things like mortgage points, mortgage interest, and real estate taxes. All costs and deductions can be calculated yearly or when you sell. Make sure to save buying and selling papers of the home purchased. Also save all receipts for costs made when updating your home, rental, or vacation home.
When selling, there are tax rules to consider, especially if you've made money on your home, rental or vacation home. If you've made money on your home above the original purchase price, your main home that you have resided in for 5 years or more, you can avoid capital gains up to $250,000 if filing single, or up to $500.000 of capital gains if filing married filing jointly.
One of the worst events you can face in life is a natural disaster like a hurricane, tornado, flood, or earthquake. In these cases, the IRS offers you relief from your tax burden in a few ways. First, if you live in an area that's been designated by the Federal government as a major disaster area, you can choose to claim disaster-related losses on your federal income tax return or your previous return to get immediate money. You may also decide to wait and claim the loss on the current year's taxes and potentially get more money.
You can get additional financial aid from the IRS and others if you are current on your federal tax returns. You'll need to determine the amount of loss be taking your adjusted basis in the property before the natural disaster and then calculate how much the fair market value decreased after the disaster. From there, take the smaller of those two amounts and deduct insurance or any other reimbursement.
Death & Inheritance
There are many scenarios that involve the death of a loved one, depending on the relationship, inheritance, and financial strategies used. If your spouse dies, this can affect your filing status for the next few years You can still file as married filing jointly for the year your spouse dies. The next two year, you can use qualifying widow status, assuming you have dependent children and don't remarry. Qualifying widow status gives you the same standard deduction and tax brackets as married couples filing jointly even though your spouse is deceased.
When a family member dies, someone still has to file that person's taxes for the final year of life. Usually, the executor of the deceased's estate handles this. But even if that's not you, your loved one's death could still affect your taxes if you're to inherit any of the deceased's retirement accounts. Most money received from an inheritance is tax-free. However, if you receive an IRA as part of an inheritance, odds are you'll be taxed on any distributions. The government is allowed to tax money in inherited retirement accounts, unless you were the deceased's spouse and you roll over the money into your own retirement account, in which case you won't owe taxes until you withdraw the money in retirement. You also won't owe taxes on Roth retirement accounts you inherit because the deceased already paid taxes on those funds in the year the contribution was made.
Keep in mind, if you received property, there is a "step-up" to your cost-basis to the value at the time of the decedent's death. If the property gains in value after that, those gains will generally be taxable. The IRS does place a tax on estates that exceed the estate tax exemption. However, since that tax exemption is in the millions, there are very few estates that have to pay that tax. Depending on the size and composition of the assets in the estate, an estate tax return may also need to be filed. Remember to check on state's requirements because some states do charge an inheritance tax, though the rules do vary by state.
If you have any questions regarding any tax issue. please feel free to contact us at Tax C.A.T.S. We would love to help with any tax issue that you may have.
Marla Holly Conner