Tax Issues When Planning Marriage or Divorce
By Peter Jason Riley
When planning to marry, don't forget the IRS! Weddings often spring a tax trap known as the "marriage penalty." This penalty applies because many tax rules discriminate against two-earner married couples.
- Standard deduction. For example, the standard deduction for married taxpayers is less than the standard deduction for two single individuals. In the 28% tax bracket, a couple could pay $350 additional tax on the difference in standard deduction alone.
- Tax rates. If you're married, the combined income of you and your spouse may push you into a higher tax bracket than either of you would be in as singles. This feature in the tax law creates a "penalty" on marriage that gets more severe as two-earner income rises.
- Earned income credit. Wealthy taxpayers are not the only ones who are affected by the marriage penalty. If your income is low enough, you can qualify for the earned income credit. Married taxpayers must report their combined income, but unmarried taxpayers with only a single income to report, find it easier to qualify for the credit.
- Social security benefits. A penalty also hits marrieds receiving social security benefits. If you're married, you must combine your incomes, pushing you over the taxability threshold more quickly than singles. The law may subject a higher percentage of your benefits to income tax, so the penalty for being married increases here, too.
- Other areas. Differences between singles and married couples also exist in the rules governing capital losses, mortgage interest, and rental property losses, to name only a few.
- Planning could help. One way to avoid the marriage penalty is to remain single, but letting taxes determine your marital status is not recommended.
However, if you're planning a year-end wedding, you may want to consider delaying your marriage until next year. Not all married taxpayers pay more. Whether you will depends on many variables. We can help you determine whether the marriage penalty affects you, and what, if anything, you can do to minimize it.
If you're going through a divorce, taxes may be the last thing on your mind. But divorce involves many potential tax traps and pitfalls. Here are some things to watch out for.
- Alimony and child support. Alimony is taxable income to the person who receives it and deductible by the person who pays it, as long as it meets certain specific tax requirements. Child support is neither taxable nor deductible. A divorce agreement should clearly spell out the difference between alimony and child support.
- Property settlement. When a divorcing couple agrees to a property settlement, there are no immediate tax consequences. But when it comes time to sell the property, one of the parties could be in for a nasty tax surprise. That's because each spouse receives property with its original tax basis, and a low tax basis may trigger a large capital gain down the road. A truly equitable property settlement should consider the tax basis of assets, not just current market value.
- Children. After divorce, the parent who has custody of a child for the greater part of a year generally has the right to claim that child as a dependent. However, the custodial parent may transfer the dependency exemption to the other parent by signing the appropriate IRS form. Why would you ever give away a deduction? Because it may be worth more to your ex-spouse. In exchange for the dependency deduction, you may be able to bargain for more alimony or a larger property settlement.
- Tax filing. As a married couple, you probably have been filing a joint tax return. But during divorce proceedings, you may be better off filing separately or, if you qualify, as head of household. Once the divorce is final, your filing status will be either single or head of household. To qualify as head of household, certain requirements for dependents must be met.