If you are going through divorce or have divorced recently, one important task is for you to understand how to maximize tax-saving strategies after divorce.
Here are 5 tax strategies to maximize your savings.
This is a guest blog post by Sally Boyle, a Certified Divorce Financial Advisor in West Lebanon, New Hampshire.
First, you’ll file based on your marital status as of December 31 of the tax year. So, for example, if you were still married on December 31, and your divorce is final in February, you will need to file one last joint tax return for that tax year. If your divorce was final before December 31, then you would file as single or head of household.
Once you start filing your own return after the divorce, you will want to take advantage of tax strategies that may not have been available during your marriage.
What often changes for the newly divorced is not their income level but how that income is characterized. If you are receiving child support, or spousal support that began January 1, 2019 or later, that income is non-taxable to you.
As some divorcing clients transition back into the workforce, in the years immediately following their divorce, they may find themselves in the lowest tax bracket of their life. They might also find they can benefit from tax advantages and credits that they could not during their marriage.
Strategy 1: Earned Income Tax Credit
First, the earned income tax credit gives sizable reductions in taxes to workers with low- or mid-level incomes. The credit amount varies by family size and income, with maximums of $6,660 for those with three or more children, $5,920 for those with two children, $3,584 for those with one child, or $538 for those with no children.
For those filing single or head of household, the income limit for no children is $15,820, one child is $41,756, two children $47,440 and three children or more $50,594. These income limits indicate which taxpayers are eligible for at least some of the earned income credit, and they phase out in between.
Uniquely special to the earned income tax credit is that even if you do not owe any taxes, you can still get the credit amount back from the IRS in the form of a refund.
Strategy 2: Child Tax Credit
A second example, the child tax credit is a simple provision, paying $2,000 for each eligible child. To qualify, children must be 16 or younger at the end of the tax year, and the person claiming the credit must live with the child for more than half the year and provide at least half of the child’s financial support. Also, to get the full credit, your income must be no greater than the $200,000 for single or head of household, while $400,000 for married filing jointly . For many divorced parties, prior to divorce, their joint incomes could have exceeded $400,000. But post-divorce, with potential nontaxable income, their income could easily be less than $200,000.
Strategy 3: American Opportunity Tax Credit
And what about credits for educational costs? The American Opportunity tax credit pays 100% of eligible tuition and required fees up to $2,000, and another 25% of the next $2,000, making for a total maximum credit of $2,500 per year. It is available for four years of undergraduate education, and taxpayers can claim the full credit if they make less than $80,000 for singles or head of household. Reduced amounts are available for incomes up to $90,000.
Note that this tax credit can only be claimed by the custodial parent (as defined by the IRS). Even if some or all of the tuition is paid by the non-custodial parent, the custodial parent can claim this credit.
Strategy 4: Lifetime Learning Tax Credit
Meanwhile, the Lifetime Learning tax credit offers additional educational tax breaks even beyond traditional college. A 20% credit on up to $10,000 in eligible expenses every year is available to taxpayers making less than $59,000 if they are single or head of household, with reduced credits available up to $69,000. This credit is available for graduate school, vocational training, and certain other nontraditional educational expenses. If you are getting education or training to go back into the workforce, this can substantially reduce the cost of your re-education efforts.
Strategy 5: Capital Gains and Investments
There are many other tax benefits that divorced parties could enjoy in those years post-divorce where their actual taxable income might be substantially lower. For example, their capital gains tax could be 0% if their income is less than $40,000 as a single or $53,600 as head of household. Maybe this is the year they should realign their portfolio and take some capital gains. This might also be the year that they consider converting some pre-tax retirement accounts to Roth accounts reaping substantial tax savings at withdrawal.
The greatest takeaway from all of these examples is that for every new divorce case we can assist with the tax issues. A tax discussion should be a part of our conversations before settlement. Preparing the tax calculation encourages us to ask very different questions as well as encourage our divorcing clients to look forward.
Sally J Boyle
CFP CDFA CSRI