Tax Implications of Children & Divorce

This time of year, many of us are thinking about taxes. It can be tough for anyone but even more challenging if you’re going through a divorce. Not only do the financial outcomes of a divorce have a lasting impact on one’s family, but more specifically, the financial outcome itself depends quite a bit on how we look at the children and the tax benefits that come with them.

As a father of 4, I am reminded each year in April how big of an impact a child can have on the taxes we pay. Sure, I understand that with each child comes that much more in expenses (at least I think I have figured that out), but with each child I also see the increasing benefits that exist in our tax law. With a good understanding of the benefits that exist, we are often able to find sizable tax savings for divorcing couples with children.

Take, for example, an all too common scenario that I see: A working married couple where one spouse has a six figure income and the other works either part-time or not at all to take care of the household and 4 growing children. We see couples like this struggling to support the one household, and the mounting financial concerns continue to put a strain on their relationship. A household income of $120,000 doesn’t seem to go too far. As married, filing joint, this family would have just over $99,000 in after-tax income. In a divorce scenario this same couple could find close to $8,000 a year in additional after-tax income just by changing the way they file their taxes. That’s over $650 a month they can now put towards their child’s education, daycare or the mounting variable child expenses.

Yes, it’s true that we often see expenses increase after a divorce, but think about how far an extra $650 per month would go for a parent with a part-time job struggling to raise 4 kids. What often concerns me the most in working with divorcing couples is seeing how many families do not even exploring the possible tax savings that are available to them. Thousands of dollars are paid in taxes that could have been very useful to parents and their children. Neutral Financial Specialists are able to analyze these options and, more importantly, educate the couple and the collaborative team on how and why they exist. Here are some of the most common child related tax benefits:

The Dependent Exemption – The dependent exemption is a $4,050 deduction from your taxable income. You can only deduct the lesser of the exemption amount or your taxable income.

The Child Tax Credit – The child tax credit is a $1,000 credit against tax owed for each eligible child. An eligible child must be under age 17 (16 years old) as of December 31 of the tax year. You must have a tax liability to have a child tax credit. This is not a refundable credit. The credit amount is phased out at a rate of 5% of AGI which exceeds $75,000 if filing head of household or $110,000 if filing married joint.

The Additional Child Tax Credit – If the tax liability is less than the child tax credit, the client may be eligible for the additional child tax credit. This credit is fully refundable and referred to as a payment. This credit, in addition to any child tax credit, cannot exceed the number of children multiplied by $1000.

Head of Household Filing Status – Head of Household filing status is the most favorable tax filing for a single individual. You must have a qualifying child to file as head of household.

Child and Dependent Care Credit – If you have qualifying expenses for child and dependent care so you can work or look for work, you can deduct some of those expenses from your federal tax liability. If you have an AGI over $43,000 you can deduct 20% or up to $3,000 with one qualifying child or 20% (up to $6,000) with 2 or more. The child must be under age 13 (12 years old) when care was provided. If you have an AGI of less than $43,000 the percentage increases based upon income to a max of 35% with $15,000 or less of AGI. This credit, like the child tax credit, is only a credit against federal tax owed and is not a refundable credit.

Exclusion of income for dependent care benefits – If an employer provides dependent care benefits under a qualified plan, the person may be able to exclude those benefits from income. You can exclude up to $5,000 of dependent care benefits.

From the neutral financial specialist point of view, our job is to educate and inform the collaborative team about the many ways to maximize the available income for the family. This is our way of ensuring parents can maximize their financial means to care for their children. Although we do not meet directly with the children or hear their feedback, we can certainly make a lasting impact on the family and the future co-parenting relationship.

Grant Zielinski, CDFA
Divorce Financial Solutions, Inc., Milwaukee
Member Since 2009