Article Highlights:
Tuition Credit – If the 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. Credits are significant tax benefits because they reduce the dollar-for-dollar tax bill; deductions, on the other hand, reduce taxable income before the tax amount is calculated according to the individual’s tax bracket. For instance, the AOTC provides a tax credit of up to $2,500, 40% of which is refundable. However, both education credits phase out for high-income taxpayers and effective for years after 2020 both credits phase out between $80,000 and $90,000 for unmarried taxpayers and between $160,000 and $180,000 for married taxpayers.
Child Care Credit – A nonrefundable tax credit is available to the custodial parent to offset the cost of child care, provided that the parent is gainfully employed or seeking employment. To qualify for this credit, the child must be under the age of 13 and be a dependent of the parent. However, there is a special rule for divorced or separated parents; when the custodial parent releases the child’s exemption to the noncustodial parent, the custodial parent still qualifies for the child care credit, and the noncustodial parent cannot claim that credit. Credit The credit is a percentage of the expenses and ranges from 35% for lower income taxpayers to 20% for the higher income ones. The expenses used to determine the credit are limited to $3,000 for one child and $6,000 for two or more. Note: A substantial one year (2021) increase in the credit is included in President Biden’s American Rescue Plan.
Child Tax Credit – A credit of $2,000 is allowed for each child under the age of 17. This credit goes to the parent who claims the child as a dependent. Up to $1,400 of the credit is refundable if the credit exceeds the tax liability. However, this credit phases out for high-income parents, beginning at $200,000 for single parents and at $400,000 for married parents filing jointly. President Biden’s American Rescue Plan also includes a one-year increase to $3,000 ($3,600 for children under the age of 6).
Earned-Income Tax Credit – Low-income parents with earned income (either wages or self-employment income) may qualify for the EITC, which is based on the number of children (all those under age 19, plus full-time students under age 24), up to a maximum of three children. Releasing dependency to the noncustodial parent does not disqualify the custodial parent from using children to qualify for the EITC. In fact, the noncustodial parent is prohibited from claiming the EITC based on children whose dependency the custodial parent has released.
Alimony – The tax reforms enacted in late 2017 also impact the tax treatment of alimony. For divorce agreements that were finalized before the end of 2018, the recipient (payee) of the alimony must include that income for tax purposes. The payer in such cases is allowed to deduct the payments above the line (without itemizing deductions); this is technically referred to as an adjustment to gross income. The recipient who includes this alimony income can treat it as earned income for purposes of qualifying for an IRA contribution, thus allowing the recipient to contribute to an IRA even if he or she has no income from working.
Because some of those who make alimony payments will claim that they paid more than they actually did, and because some recipients will report less alimony income than they actually received, the IRS requires that the paying spouse’s tax return include the recipient spouse’s Social Security number so that the IRS can use a computer to match the amount received to the amount paid.
For divorce agreements that are finalized after 2018, alimony is not deductible by the payer and is not taxable income for the recipient. Because the recipient isn’t reporting alimony income, he or she cannot treat it as earned income for the purposes making an IRA contribution.
This revised treatment of alimony also applies to any divorce or separation instrument that is executed before the end of 2018 but modified after that date – if the modification expressly provides that the tax reform provisions apply.
As you can see, some complex rules apply to divorce situations. Please consult this office if you have any questions related to a pending divorce action. Please note that, if this office has been providing services to both parties in a pending divorce, there are some inherent conflicts of interest in providing advice or preparation services to both parties, so this office may be able to provide services to only one member of the former couple.
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