Divorce is a process that affects a multitude of aspects in a family’s life. Relationships that were premised on lasting are being dissolved between spouses. New living arrangements may take place. Parents’ time with the children may be drastically altered. A two-income household where parents share responsibilities is split, and now each spouse may be entirely responsible for their own household – both financially and in terms of day-to-day upkeep. This change can be tremendously stressful and is certainly an emotional process. The attorneys at Ciyou & Dixon, P.C. are cognizant of this fact; however, the major issues surrounding a divorce, legally speaking, basically consist of two parts: (1) what happens to the children of the marriage, and (2) who gets what out of the marital estate? This blog post addresses both questions while leaning toward the financial side – what are the current tax laws that may affect a divorce, and what do they mean?
Dependency Exemption: The Tax Cuts and Jobs Act of 2017 suspended a $4,050 deduction per dependent claim on tax returns. This is, in part, because the standard deduction was increased substantially. Often in negotiating a final agreement or in arguing at a final hearing, the ability of a parent to claim a child of the marriage as a dependent was important because of the substantial deduction. The elimination of this deduction may have led some attorneys to believe that claiming a child as a dependent on a tax return is no longer an important issue. As described below, it remains something that must be addressed.
Child Tax Credit: This is a tax credit for the parent claiming a child as a dependent. This credit may be up to $2,000 per qualifying child under the age of 17 and up to $500 per dependent other than a qualifying child.1 There are certain restrictions/phase-outs when adjusted gross income reaches a certain threshold.
Child & Dependent Care Credit: This is a tax credit for the custodial parent only (you do not have to claim dependency exemption). This credit only applies for children under the age of 13, and the credit may be up to 35% of $3,000 for one (1) child or $6,000 for two (2) children. This credit may be reduced if adjusted gross income is greater than $43,000 for a head of household.
Earned Income Credit: This is a tax credit for a custodial parent (you do not have to take a dependency exemption). The credit is assigned based on the number of children you may have. It is subject to some restrictions/phase-outs if investment income reaches a certain level or if adjusted gross income reaches certain levels. It is important to note that spousal maintenance and child support are not considered earned income.
American Opportunity Education Credit: This credit is available the first four (4) years of college, and the maximum annual credit is $2,500. This credit follows the dependency exemption regardless of who pays the expense. This credit may be phased out if adjusted gross income reaches a certain level. Also, this credit is applicable to the person claiming the dependence exemption regardless of who paid the college expense.
Important Consideration: Tax Benefits Related to Education may be treated as “Financial Aid.” The Indiana Court of Appeals, in the case of R.R.F. v. L.L.F., 935 N.E.2d 243 (Ind. Ct. App. 2011), examined the effect of one parent obtaining tax benefits related to a child’s education. This case involved a portion of the Indiana Child Support Guidelines that states that the tax laws “provide tax credits and preferences which will subsidize the cost of a child’s post-secondary education” and that “no one party should disproportionately benefit from the tax treatment of post-secondary expenses.” In sum, the Court of Appeals held that a tax credit for a child’s education expense should first be considered as a reduction to both parents’ obligation to a child’s college expense (regardless of who received the credit), and then a trial court should apportion each parent’s obligation toward education expenses. Here is a very broad and simple example just to explain how the arithmetic works:
A trial court reasons that child, father, and mother are each to pay one-third (1/3) of college expenses that are $10,000 per year. This means that child, father, and mother are each responsible for $3,333 per year. But, father obtains an AOEC credit for $2,500. Now, the total of the parents’ combined obligation ($6,666) is reduced by the credit ($2,500) to $4,166. Since both father and mother pay an equal share, their respective education obligation to the child is $2,083 ($4,166 divided by 2).
The key takeaway from these cases is that tax implications in a divorce remain important and can have real implications on one’s finances. Having an attorney well-versed in these issues is critical. Ciyou & Dixon, P.C. attorneys practice throughout the State of Indiana and understand the issues surrounding financial agreements and/or issues for a trial/final hearing in a divorce. This blog post is written by Ciyou & Dixon, P.C. attorneys and is not intended as specific legal advice or a solicitation for services. THIS BLOG IS NOT TAX ADVICE AND THE FIRM DOES NOT PROVIDE TAX ADVICE. It is an advertisement.
- The purpose of this blog is to identify crucial tax issues and provide a general outline for the issues that one may face as a divorcing parent. Such terms as “qualified” child may be fact-sensitive, and a tax professional should be consulted for guidance on whether a child “qualifies” under the tax laws. Likewise, this is not an exhaustive list of child-related tax benefits that one may need to address. This blog is advertising material, and it is always prudent to consult a tax professional with tax questions related to your specific set of circumstances.