May 1, 2018
Gone, But Not Forgotten
This year there have been many changes to the income tax code. One of the most notable is the “elimination” of the personal exemption. In actuality this exemption is not gone and still has an impact on divorces involving children.
Let’s start by looking at what the personal exemption used to be. Before January 1st, 2018 a taxpayer was allowed a personal exemption for each qualified person in the household. “Qualified persons” included the taxpayer, his or her spouse, children under 18 (or under 24 and in college), and other household members for whom the taxpayer provides more than 50% of their support*. For each of those persons the taxpayer was allowed a deduction of $4,050.
The tax reform package enacted this year removed the monetary value for personal exemptions. However, you are still required to list each dependent on the tax return, and this list will affect two potential tax credits for divorced parents: the Earned Income Tax Credit and Tuition Credits.
Head of Household: The ability to list dependents rests on which parent qualifies to be “Head of Household.” For divorced individuals, the ability to claim the Head of Household (HOH) title versus single taxpayer means a substantial tax savings. The new standard deduction for HOH is $18,000, a 50% increase over the single taxpayer standard deduction of $12,000. Therefore, the conversation around who will provide the majority of the support for children is still important because HOH is awarded to the parent at whose home the child(ren) sleep the most.
The definition of HOH is clearly defined and there is no “trading” Between ex-spouses. However, you can give the ability to list the dependents to your ex-spouse while still maintaining the right to the HOH standard deduction. This is accomplished by having the spouse who is giving away the right to list the dependents file Form 8332 with their tax return. The giving spouse will file as HOH, will not list the dependents and will supply Form 8332 with their return to clarify why no dependents were listed. If there is more than one child in the household, listing the children could be determined on a child by child basis. For example, if there are two children, each spouse could list one child on their return. The ability to trade the exemption is a useful tool to ex-spouses who would both benefit from claiming tax credits (see below) and for HOH’s that do not need the tax credits.
Earned Income Tax Credits: This is a tax credit for low income earners. Single taxpayers can qualify, but claiming dependents decreases the income threshold to qualify as well as increases the credit. The EITC is refundable, which means that you will receive a tax refund for the portion of the credit awarded to you that exceeds what you owe the IRS. For instance, if you qualify for an EITC of $2,500 and your tax liability is only $1,000, the IRS will send you a check for $1,500.
Tuition Tax Credits: There are two tax credits that may be available to those who incur qualified education expenses on their own or their dependents’ behalf; the American Opportunities Credit and the Lifetime Learning Credit. These credits are as much as $2,500 per student. There are income limits on these, and only the AOC is refundable.
The bottom line here is that despite the tax law removing the monetary value of the personal tax exemption, there is still a lot to gain in having early discussions about who will be designated as HOH and how to allocate listing dependents on returns. The HOH gains a higher standard deduction and the right to list dependents with the flexibility to gift this right to the ex-spouse.
Therefore don’t underestimate its importance. The monetary deduction is gone, but there are still significant impacts for those who are divorced with children.
*This is a generalization of qualifying individuals. See Publication 17 for more detail.