Divorce brings a new tax bracket, new filing status and, possibly, valuable tax credits. Let’s start with some basics. The tax reform in 2017 did away with any deduction for personal exemptions. This was mostly compensated by greater standard deductions. The current standard deductions for each filing status are:
- $12,550 Single
- $18,880 Head of Household
- $25,100 Married
The “Head of Household” Tax Filing Status Minimizes the Tax Burden
The Head of Household (HOH) filing status strategy is a simple way to reduce overall tax bills. Filing HOH can put you in a better tax bracket, can save money, and qualify you for the child tax credit.
To calculate the value of the Head of Household status, assume a wife has $100,000 in taxable income. Depending on her tax filing status, she could have one of the following outcomes regarding federal income taxes:
- Filing under a single status results in a tax bill of $14,864.
- Choosing Head of Household status results in a tax bill of $12,102.
By simply choosing HOH, she can save $2,762 on federal taxes.
The HOH filing requirements include:
- At least one child is under age 18.
- The divorce is final.
- The parent’s home was the child’s home for more than half the year.
- The parent paid more than half the costs of supporting the child.
Child Tax Credit
There is currently a child tax credit of $2,000 per child (directly reducing the tax bill) for single individuals earnings less than $200,000. So two children would result in a reduction of $4,000 from the tax bill.
How the capital gains tax bracket can influence the division of assets
The IRS has three different levels of taxation for capital gains (appreciation on securities or investment real estate) for the tax year 2021.
1. A 0% capital gains rate applies for those with:
- Earnings below $40,400 for a single individual,
- Earnings below $54,100 for Head of Household status and
- Earnings below $80,800 for joint filers.
2. The highest level of capital gains tax, 20%, starts at $445,850 for singles and $501,600 joint.
3. A 15% capital gains rate applies for all earnings levels in between the two above levels.
Note that there could be overall tax savings by reviewing the capital gains tax liability within the assets. For instance, if the couple has highly appreciated stock outside of IRAs and qualified plans, more of that should be assigned to the lower earner if you will have:
- Less than $40,400 in taxable earnings if single
- Under $54,100 if you are head of household, or if
- The other spouse earns more than $445,850.
Naturally, earnings don’t include child support or alimony, since both are non-taxable. And fortunately, if the divorce remains cooperative, the allocation of assets can produce a superior result in tax planning.
Be sure to consult with a Certified Financial Planner who can analyze the tax situation post-divorce.