- Newly single with kids? You just might be able to qualify for a standard deduction of $18,000 under head of household status.
- Be aware of the benefits on the table, including a $2,000 child tax credit for each kid.
- Custody arrangements can make or break your tax situation.
As divorcees decide who gets the house and how to split their assets, they should remember to address this key bargaining chip: Who gets to claim "head of household" on their taxes?
Though this tax-filing status can be beneficial to the newly single, it's also one of the most difficult to qualify for, due to its restrictions on the taxpayer and his or her dependents.
"Head of household filing status is generally better than filing single," said Dave Stolz, CPA and member of the American Institute of CPAs' personal financial specialist credential committee.
"You have to make sure that you qualify," he said. "You have to have a child living with you for more than half the year."
This status also carries with it the right to certain tax breaks, including the child tax credit.
Tax credits are valuable because they reduce your tax bill on a dollar-for-dollar basis. That $2,000 child tax credit, for instance, will save you $2,000 in taxes.
Meanwhile, deductions reduce your taxable income and help you save on taxes based on your income bracket.
For instance, a $2,000 deduction is worth $200 for a taxpayer in the 10 percent bracket, but it's worth $700 for someone in the 35 percent bracket.
Would-be divorcees beware: The extent to which you benefit from your head of household status could come down to your custody agreements.
"Let's say you have a couple with two kids and they agree to joint custody," said Stolz. "Neither gets head of household by doing that."
Here's what you should know about this complicated tax status.
Taxpayers must meet certain conditions in order to qualify as head of household. First, you must be unmarried — that is, legally separated by the end of the tax year.
If your divorce isn't finalized as of the last day of the tax year, then you're considered married.
You must also have paid more than half the cost of keeping up a home for the year — this includes property taxes, food eaten in the home, repairs and maintenance — and a qualifying person must have lived with you for at least half of the year.
Heads of household are subject to a different set of income tax brackets, which tend to be broader at the 10 percent and 12 percent brackets. See below.
This tax status also comes with a higher standard deduction.
Heads of household have a standard deduction of $18,350 in 2019. In comparison, single filers have a standard deduction of $12,200 (that number doubles to $24,400 for married couples who file jointly).
Where your kids go — that is, who claims them as dependents and whom they reside with for more than half of the year — is a driving factor in determining which parent will be eligible for certain credits.
Prior to the Tax Cuts and Jobs Act, taxpayers were able to claim a $4,050 personal exemption for themselves, a spouse and each dependent.
The tax overhaul did away with these exemptions, starting in 2018.
"The dependency exemptions are gone, but the number of dependents you claim will matter for the child tax credit," said Debbie J. Freeman, a CPA and director of financial planning at Peak Financial Advisors in Denver.
Benefits up for grabs include the child tax credit of $2,000 per kid.
The details surrounding tax status and custody can be messy.
For instance, a child may live with one parent and receive child support from the non-custodial parent, with whom he or she spends less than half the year.
If the custodial parent is paying less than half of the cost of maintaining the home, then in this case, technically neither parent may qualify for head of household, Freeman said.
"In reality, that never happens; someone will claim the dependent," she said. "But often, it's the custodial parent who takes the head of household status and overlooks the requirement for covering more than half the cost of keeping up the home."
Parents with two children might think that their divorce agreement is equitable if they opt for joint custody — spending exactly six months out of the year with each child.
In this case, neither can claim head of household.
"If you just add one more day of custody for each child, both parents can claim head of household," said Stolz.
To allow both parents a bite of the "head of household" apple on alternating years, divorcees with one child can agree to trade off on claiming the dependent.
Alternating years also works in situations where there are three or more children — considering the value of the child tax credits — one parent can claim two kids, while the other claims the third, said Freeman.
Finally, a non-custodial parent who provides support can agree to claim the child tax credit, provided the custodial parent is willing to sign it away using Form 8332, said Suzanne Shier, chief tax strategist at Northern Trust Wealth Management.
"The tax preparer actually has to certify that they have explained the rules of claiming the child tax credits in the case of divorced parents, along with the requirements of Form 8332," she said.
As you and your ex-to-be pull together your divorce attorneys and financial planners to determine a fair division of your belongings, don't forget to invite your CPA to the table to hash out the tax impact of your split.
"Don't assume that it's all or nothing," said Shier. "That's where having capable advisors to help you think it through can be extremely beneficial."