Divorce and Taxes - 10 Things to be Aware of - Part 2

Two things most sane people seek to avoid are divorce and taxes. Unfortunately, when you’re going through a divorce, not paying attention to taxes can cost you thousands. That’s especially true with the tax law changes that went into effect in 2018 and 2019. Now more than ever, not understanding how taxes will affect your divorce can be a very expensive mistake.

Last week we looked at 5 issues to be aware of. This week, we'll look at 5 more.

6. 529 Plans

529 Plans are special tax-advantaged savings accounts that parents (or grandparents) could create to save money for children’s college educational expenses.

In the past, 529 Plans could only be used to fund “Qualified Higher Education Costs.” That’s IRS speak for college/university tuition and certain other college or university expenses.

Under the new tax laws, parents can take up to $10,000 per year out of a child’s 529 Plan and use it to pay for that child’s elementary or secondary school tuition. Now, if your kids are going to private school, you or your spouse could want to use the kids’ college money to pay for it. That will save you from having to pay the private school tuition yourselves.

It will also leave your kids with less money (or no money) to pay for college.

The bottom line is that deciding what to do with your kids’ 529 Plans is now one more thing you’ve got to negotiate in your divorce.

7. Moving Expenses

Before 2018, if you were moving because of a new job, you could deduct your moving expenses from your taxable income. Now, you can’t.

While paying for moving expenses may not be a huge issue in your divorce, the truth is moving costs money. Since there is probably no way you will ever get to deduct those moving expenses from your taxes, you might want to think harder now about how you will pay for those expenses when you divorce.

8. Mortgage Interest & HELOC Payments

The new tax law limits the mortgage interest deduction to interest paid on the first $750,000 of your loan. To be deductible, the loan must also be used to buy, build, or substantially improve the home that secures the loan. That applies to home equity loans and lines of credit, too.

In the past, if a divorcing couple had a home equity line of credit that wasn’t maxed out, they could draw on that loan in their divorce. They could then use that cash to pay for their divorce expenses. Or, they could use it to balance out their property settlement or pay moving expenses.

When they withdrew that money, they could deduct the interest they paid on it from their taxes.

Now, you can still draw on your home equity line of credit in your divorce. But, if you use the money to pay for anything besides home improvements, any interest you have to pay will not be tax-deductible.

9. State & Local Tax Payments

Before 2018, you could deduct the amount you paid in real estate taxes on your federal income taxes. You could also deduct what you paid in state income tax, sales tax and other state and local taxes.

From 2018 on, you can only deduct the first $10,000 you pay in state and local taxes, including income taxes, real estate taxes and sales taxes.

If you’re thinking of keeping your home when you divorce, you’ve got to figure out if you can afford it. Not being able to deduct the full amount of the property taxes you pay can potentially cost you more in income taxes. That increases your expenses and reduces your cash flow.

10. Medical Expenses

Before 2018, you could only deduct medical expenses that exceeded 10% of your adjusted gross income. Now, however, you can deduct medical expenses that exceed 7.5% of your income.

While that 7.5% threshold was supposed to go back up to $10,000 in 2019, it didn’t. So for now at least, you can still deduct medical expenses that exceed 7.5% of your income.

Of course, in order to be to deduct medical expenses at all, you have to be able to itemize your deductions. If you don’t, then you’ll lose this deduction too.

If you have a lot of medical expenses, and you are getting divorced, the lower-income threshold for deducting medical expenses can be good news. First, when you divorce you can no longer file taxes with your spouse. So, you will have less income to declare on your taxes. Since you can deduct expenses that exceed 7.5% of your income, that means you will likely get more deductions.

Divorce and Taxes - Ten Things to be Aware of - Part 1

Two things most sane people seek to avoid are divorce and taxes. Unfortunately, when you’re going through a divorce, not paying attention to taxes can cost you thousands. That’s especially true with the tax law changes that went into effect in 2018 and 2019. Now more than ever, not understanding how taxes will affect your divorce can be a very expensive mistake.

1. Tax Status

The first thing you’ve got to remember about filing taxes after divorce is that your tax status is going to change. Married filing jointly is the most tax-favored way to file taxes. Once you’re divorced, you will lose that status.

Lots of people think that as long as they were married for some part of the year, they can still file taxes as married filing jointly. That’s not true.

Your marital status for income tax purposes is determined as of December 31. If you were married on December 31 you will file your taxes for that year as married. If you were divorced, your only option is to file either as a single person, or head of household.

2. Taxes on Alimony

Historically, alimony (also known as maintenance or spousal support) was tax-deductible to the person who paid it. The person who received alimony was the one who paid the tax on the income.

This was known as the alimony tax deduction, and it often made settling divorce cases easier. That’s because the spouse who received alimony was usually in a lower income tax bracket than the spouse who paid alimony. The alimony tax deduction allowed the couple to shift income from the higher earner to the lower earner. As a result, both spouses paid less in taxes than they otherwise would have paid.

Unfortunately, effective January 1, 2019, Congress eliminated the alimony tax deduction.

Now alimony is no longer tax-deductible to the person who pays it.

That means that if you’re paying alimony to your spouse you have to pay taxes on the income you earn at your income tax rate. Then you have to use your post-tax dollars to pay spousal support to your ex.

3. Personal Exemptions

Before 2018, when you filed your taxes, you got to claim yourself, and each of your kids, as dependents on your taxes. Known as “personal exemptions” or “dependency exemptions,” these tax breaks allowed you to subtract a certain amount of money from your taxable income for every dependent you claimed. The more dependents you claimed, the more money you could subtract.

Unfortunately, from 2018 through 2025, no one gets a tax exemption for claiming the kids as dependents. But then in 2025 (theoretically, at least!) the dependency exemption will spring back to life. Although neither parent will get a tax exemption for claiming the kids as dependents through 2025, theoretically, that will change in 2026 and beyond. So, if your children will still be underage in 2026, you and your soon-to-be-ex still need to decide who gets to claim the dependency exemption for them from 2026 on.

Finally, while the dependency exemption itself may not be worth anything for a few more years, deciding which parent can claim which child as a dependent may affect the child tax credit.

The bottom line is that, divorcing parents still need to decide which parent is entitled to claim which child as a dependent in any given year.

4. Child Tax Credit

Even though the dependency exemption has no value (at least through 2025) unless a parent has the right to claim a child as a dependent, that child might not qualify for the child tax credit on that parent’s income taxes. That’s why, in your divorce, you still need to negotiate which parent can claim each child as a dependent in every year.

If you don’t say who can claim the child as a dependent, you risk losing the child tax credit. The child tax credit directly reduces the amount of income tax you pay. So, it doesn’t just reduce your taxable income. It reduces your taxes.

5. Health Insurance

Not considering how claiming the children on your taxes can impact the health insurance you get for them on the Health Insurance Exchange has become an expensive trap for the unwary.

Most divorcing spouses agree to split the right to claim their children on their taxes in any given year. So either, mom gets to claim the kids in even years and dad gets to claim them in odd years, or mom gets to claim Child A, Dad gets to claim Child B, and they alternate claiming Child C. Doing this is easy and it seems fair enough.

But if dad claims Child B on his income taxes while mom gets health insurance for Child B through the health insurance exchange based on her taxes, mom might end up having to repay the government for that portion of Child B’s health insurance that the government subsidized! The same thing is true if mom claims the kids on her taxes in one year, but dad gets health insurance for the kids through the exchange based on his income.

How is Child Custody Determined?

If you have ever been involved in a child custody case or you are about to begin one you most likely have heard the phrase “best interests of the child.”

Almost every state determines child custody and visitation issues based on the best interests of the child standard.

State statutes and case law define this standard differently, but in general there are certain factors and themes that appear in the majority of states.

So when you ask the inevitable question of “how is child custody determined”, here is a general list of what the courts use to analyze the “best interests of the child,”:

• The love, affection, and other emotional ties existing between the parties involved and the child.
• The capacity and disposition of the parties involved to give the child love, affection and guidance and to continue the education and raising of the child in his or her religion or creed, if any.
• The capacity and disposition of the parties involved to provide the child with food, clothing, medical care or other remedial care.
• The length of time the child has lived in a stable, satisfactory environment, and the desirability of maintaining continuity.
• The permanence of the existing or proposed home or homes.
• The moral fitness of the parties involved.
• The mental and physical health of the parties involved.
• The home, school, and community record of the child.
• The reasonable preference of the child, if the court considers the child to be of sufficient age to express preference.
• The willingness and ability of each of the parties to facilitate and encourage a close and continuing parent-child relationship between the child and the other parent of the child and parents.
• Domestic violence, regardless of whether the violence was directed against or witnessed by the child.
• Any other factor considered by the court to be relevant to the particular family.

So playing a part in the child custody analysis will be your location at the time of the divorce, your relationship with your children, your relationship with your spouse, who was the primary caregiver, where the children have an established, familiar environment, where the children go to school, which parent is more likely to encourage the children’s current religious education, etc.

Defining A Substantial Change Of Circumstances For Custody Modification

After a divorce or child custody determination, one thing that frequently comes up is the desire to modify the court’s order. 

 It is well understood that child custody is always modifiable until the child reaches the age of 18. And while that sounds simple enough, the court will often reject petitions for change citing that there has not been a substantial and material change of circumstances since the entry of the last order.

This raises two questions: What constitutes a substantial and material change, and when does this change have to occur?

After a divorce or child custody determination, one thing that frequently comes up is the desire to modify the court’s order.

 

It is well understood that child custody is always modifiable until the child reaches the age of 18. And while that sounds simple enough, the court will often reject petitions for change citing that there has not been a substantial and material change of circumstances since the entry of the last order.

 

This raises two questions: What constitutes a substantial and material change, and when does this change have to occur?

Defining a material change in circumstances

 

Few ideas in law are so vague as the idea of what is actually a substantial and material change in circumstances in terms of child custody.

The short definition is that a substantial and material change is whatever the judge wants it to be. The long definition is a little more complex and state-specific.

In general, a substantial and material change as it concerns child custody can be any of the following:

• The parents have moved and now live a substantial distance apart so that the previously ordered visitation cannot be accomplished. This is especially true where one parent moves out of state.
• The child has started failing in school and is at risk of being placed on a remedial educational track.
• The custodial parent has started living with someone else. This becomes most influential when the new cohabitant has a criminal record.
• One parent is refusing to comply with the ordered visitation or custody.
• The child is starting school. This arises when the child was not in school at the time of the initial order.
• The child is substantially older than at the time the order was entered.
• The child has stated a preference. This only comes into play when the child is old enough to voice his/her opinion in court. Each state has different rules regarding the testimony of children.
• When one parent is charged with some type of familial abuse.

Obviously, this is not an exhaustive list but examples of situations that normally arise to the level of a substantial and material change.

Each judge has the discretion to give greater weight to different changes in circumstance.

When you should file for a modification

The second question is when the change should arise. This may seem simple on its face, but frequently it is not.

The substantial and material change must take place after the entry of the last order regarding custody or visitation, meaning it was not present during the initial hearing.

It is common for parents to argue about each other’s bad acts, but if they existed at the time the last order was entered, the continuation of the act does not constitute a change.

An example of this would be if the mother has always drank a lot around the children, but she has never let her drinking cause any physical harm to the children. If the father raised this issue at the initial custody/visitation hearing, then raising it later would not constitute a change.

On the other hand, if the mother was arrested for driving under the influence after the initial order was entered and had one of the children in the car, it would be cause for a change because the children are now in danger.

That is why it is important to understand not only what constitutes a substantial and material change of circumstances, but also to understand when the change must take place to help you succeed in your custody modification.