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Nov 17, 2022
Throughout your life there will be certain occasions that will significantly impact not only your day-to-day living, but also your taxes. Here are the top six life events and their potential tax implications:
Getting Married: If you got married recently, congratulations! Getting married is a big step in your life and could potentially impact your tax return in the form of filing status, tax bracket, total taxable income and address changes, to name a few. Whether a couple marries on the first day of the year, the last, or somewhere in between, they will now file as a married couple. There are two options for this: Married Filing Jointly or Married Filing Separately. Many couples decide to consolidate paperwork and file jointly, which opens additional tax deduction possibilities. Some examples of these are the American Opportunity Tax Credit (AOTC) & Child and Dependent Care Credit. Spouses with very different salaries might benefit most from filing jointly. It is possible that the combined incomes could get you to a lower tax rate bracket when married filing jointly. Jointly filing couples also have much higher income cutoffs to be eligible to make Roth IRA contributions. They can contribute to a Roth IRA if the modified adjusted gross income on their joint return was less than $214,000 in 2022 ($208,000 in 2021). When determining whether to file jointly or not, it’s best to consider your income and what deductions and credits you’re eligible for before deciding.
Having Children: Kids change your life in so many ways, not the least of which is your tax return. If you have the flexibility within your financial plan, there is no better time to begin planning for your child’s future education. The tax code offers two tax favored education savings accounts – the Coverdell account, allowing a maximum contribution of $2,000 per year, and the Qualified State Tuition plan, more commonly referred to as a 529 plan. A 529 plan allows large sums of money to be put aside for your child’s education. Contributions to a 529 plan are considered completed gifts for federal tax purposes. In 2022, up to $16,000 per donor ($15,000 in 2021), per beneficiary qualifies for the annual gift tax exclusion amount. Individuals can put up to $80,000 into a 529 plan over a five-year period while still having that money excluded from the gift tax. Married couples filing jointly can do the same for up to $160,000. However, they would need to put a hold on making further annual contributions for those five years. If you decide to contribute more than the annual gifting exclusion amount, that does not necessarily mean you will have to endure a gift tax, you will simply need to report the gifts on the Federal Tax Form 709.
There is no federal tax deduction for contributing to either of these programs, but the earnings from the plans are tax-free if used for qualified education expenses, so the sooner the funds are contributed the greater the benefit from tax-free earnings. Some states do allow a tax deduction on the state level if you contribute to their specific state-sponsored 529 plan.
Buying or Selling a Home: If you just purchased a home, you should consider itemizing the deductions on your return to avail the numerous tax benefits available to homeowners. New deductions available include property tax payments and qualified home mortgage interest. However, if the standard deduction amount for your filing status exceeds the total of all itemized deductions the law allows you to claim, you will not get a tax benefit from the home mortgage interest and property tax payments. When you decide to sell your current home, you may be eligible to exclude up to $250,000 of the gain ($500,000 for a married couple) from income if the property has been owned and used as your primary residence for any 2 of the 5 years just prior to the sale.
Filing for Divorce: If you recently divorced or are contemplating divorce, you will need to plan for significant tax issues such as asset division, alimony, child support, and a change to your tax-return filing status. Under divorce or separation instruments executed on or before December 31, 2018, alimony payments are deductible by the payer and taxable to the recipient. However, under divorce or separation instruments executed after December 31, 2018, alimony payments are neither deductible by the payer nor taxable to the recipient.
Child support payments are neither deductible by the payer nor taxable to the recipient. If a child qualifies for either of two higher-education tax credits (the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Credit), the credit goes to whomever claims the child as a dependent even if the other spouse, or someone else, is paying the tuition and other qualifying expenses.
Generally speaking, when a divorce settlement shifts property from one spouse to another, the recipient likely does not pay tax on the transfer. During this process, the tax basis on the property shifts as well. If you get a property from your ex-partner and sell it, there is a good chance that you could end up owing capital gains tax on all appreciation in the property, including from before the transfer.
Retirement: Retirement can significantly impact your cash flow needs. To avoid additional financial stressors in your golden years, tax strategies and financial planning are essential to make sure that you stay on track. One of the biggest changes in retirement is that instead of contributing to tax-deferred retirement savings plans that reduce your taxes, you will start tapping those savings for income and paying taxes at your regular rate.
Regular IRA and 401(k) distributions are taxed as ordinary income, but you are not required to take distributions from those accounts until you reach 72 years old (70 ½ if you reach 70 ½ before January 1, 2020). Subsequent annual withdrawals from these accounts are due by December 31 of each year – also known as Required Minimum Distributions. Generally, up to 85% of your Social Security income is taxable if your combined gross income is at least $34,000 ($44,000 for Married Filing Jointly).
Taxes are less of an issue when it comes to taking distributions from a Roth IRA account. Since Roth accounts are funded with after-tax dollars, you can take advantage of the tax-free growth on your contributions in later years. Once you reach age 59 1/2, and five years have passed since you first contributed to your Roth IRA, you may withdraw funds tax-free. Additionally, you are not required to take mandatory distributions from your Roth IRA, which means you do not have to incur additional income tax during retirement and can potentially keep your income tax rates low. Roth IRA withdrawals, since they are not taxable in retirement, do not count toward your combined annual income. Having a combination of these different types of accounts will allow you flexibility in recreating the cash flow you will need during retirement and your financial advisor at Summitry can help to establish an optimization plan for those distributions.
Death of a Loved One: Losing a family member is always difficult emotionally, and unfortunately, can be accompanied by several tax issues depending on the relationship, inheritance, and financial strategies used. Family members usually file an estate tax return with the IRS when a loved one dies.
Inheriting money brings about special tax implications depending on the type of assets received. For example, if you inherit a traditional IRA or 401(k), you will be taxed on any distributions you take as ordinary income. If you inherit property, there is what is known as a “step-up” in the cost basis to the fair market value of the property at the time of your loved one’s death. This helps you avoid being taxed on some of the gains on the property. The IRS also levies a separate tax on estates that exceed the estate tax exemption amount which is currently at $12.06 million in 2022 ($24.12 million for a married couple).
For a surviving spouse, this can be more complicated depending on your state of residence. How the property was titled, and the community property status of your state are just two of the factors that determine tax consequences. If the deceased spouse’s assets and prior reportable gifts exceed the current lifetime inheritance exclusion an estate tax return may also be required. However, the lifetime inheritance exclusion is prone to changes, oftentimes annually, so it is best to work closely with your CPA and Financial Advisor during such a life event.
Many couples have created Living Trusts that, while they are both alive, do not require a separate tax return to be filed for the trust. But upon the death of one of the spouses, this trust may split into two trusts, one of which remains revocable and the other becomes irrevocable. A separate income tax return for the latter trust will usually have to be prepared and filed annually.
These are just a few major life events that can impact your personal taxes. Whether you’re facing a surprise or a carefully planned event, your financial advisor can help you navigate the financial and tax implications so that you’re making the most informed decisions for yourself and your family.
Interested in learning more about how we consider tax planning as part of your broader financial plan? Contact us today!
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