Life Events That Affect Your Tax Return

 

 

Filing your taxes each year is not only a measure of your income and tax obligations, it's a way of recording and keeping up with certain life milestones and life events that affect your tax return. Depending on what sort of changes you've gone through during the past year in your marital status, housing situation or career, you might also need to be prepared for some tax implications as well.

Here are a few life events that affect your tax return — and how they could make a difference on your taxes.

 

Buying a home

Buying a home can bring big changes to your monthly budget, as well as to your tax return. If you're a first-time homebuyer, you might get to claim certain deductions on your taxes for the first time, such as the home mortgage interest deduction and a deduction for the local property taxes on your home.

However, the new tax law that took effect in 2018 brought some changes to the system of home-related tax deductions. Some people might no longer be better off itemizing their home mortgage deductions, and there is now a $10,000 limit per household on the amount of total state and local tax that can be deducted for federal tax purposes. Be prepared to double-check to get whatever tax breaks you qualify for as a homeowner, but don't assume that the tax deductions will make a big difference in your total costs.

 

Getting married

Going from life as a single person to life as a married couple can also significantly impact your tax return. If you're a married couple filing jointly, you qualify for a standard deduction of $24,500 (instead of only $12,000 for a single person), and various other tax benefits and financial protections that can be advantageous to your bottom line.

For example, if you are a high-income earner in a higher marginal tax bracket and you marry a lower-earning spouse, your combined income might fall under a lower marginal tax rate as a couple than you were paying as a single person. Married couples also have certain rights to survivor's benefits, eligibility to contribute to a spousal Individual Retirement Account, spousal benefits from Social Security and exemption from estate taxes.

 

Having a child

Welcoming a child into your family is one of the most profound acts of love — and it also has effects on your taxes! The new tax law doubled the annual child tax credit to $2,000 per child (and the credit does not phase out until a joint-filing couple reaches an adjusted gross income of $400,000).

Want to save money for your child's future college expenses or private school tuition? You can set up a 529 plan for that — and depending on which state you reside in, you might qualify for a state income tax deduction on the money you contribute.

 

Becoming self-employed

Starting your own business is a dream come true for many entrepreneurs; the new tax law offers a significant 20% deduction of qualifying business income for small business owners who are doing business as a pass-through entity (LLC, S corporation, partnership or sole proprietorship). As a business owner, you will also have the ability to deduct certain qualifying business expenses. You might even be able to deduct part of your monthly mortgage payment and housing expenses if you have a home office or use part of your home for your business.

 

Going back to school

If you go back to school, whether it's to earn a degree, get a specific credential or to improve your job skills, you might qualify for the Lifetime Learning Credit, which is worth up to $2,000 per tax return.

 

Starting a new or second job

If you are starting a new job, you might need to make some adjustments to your tax withholdings to avoid unpleasant surprises on your tax return. If you are taking on a second job to earn extra money on a part-time basis or as a side gig, make sure to save plenty of money for taxes in case your extra income causes you to owe extra money to the IRS at tax time.

 

Selling a home

Whether you're ready to move on from your starter home, have a growing family, got a new career opportunity in another city or have other life circumstances that make you want to move, selling your home can have tax implications, too.

If you earn a profit from the sale of your home, you can generally receive this profit tax-free — up to a limit of $250,000 of profit for singles or $500,000 for married couples filing jointly. Any profit over that limit has to be reported as a capital gain on Schedule D of your tax return.

However, not just anyone can claim this tax-free profit on the sale of a home. To qualify, you must:

• Have used the home as your principal residence for at least two out of the five years prior to the date of the sale.
• Have owned the home for at least two years during the five years prior to the date of selling the home.
• Have not sold another home for this tax-free gain within two years prior to selling this home.

 

Getting divorced

Getting divorced can make it harder to plan for retirement, and there are also some immediate tax-related implications of ending your marriage. According to a study from the Center for Retirement Research at Boston College supported by Prudential, there are a few tax impacts of divorce that divorcing couples should be aware of:¹

• As of 2019, alimony is no longer tax-deductible for new divorces. This may result in less alimony being paid, because the higher-earning ex-spouse no longer gets a tax deduction for those payments.
• Getting divorced may put you in a lower tax bracket and may reduce your tax burden.
• Child tax credits can be claimed only by the one parent who can claim the children as dependents on their tax return.

 

Retirement

Entering retirement is the ultimate goal after a life of hard work and diligent saving and investing, but retirement brings a few tax-related changes to be aware of. Use these tax planning tips for retirees:

• Are you downsizing to a smaller home? Depending on the value of your home and how much profit you make on the sale, you might need to pay capital gains tax on a portion of the profit. Be sure to put some money aside for possible tax liabilities.
• Make sure you are paying taxes throughout the year. Just because you're not working anymore doesn't mean you don't owe taxes. Make quarterly estimated payments or have taxes withheld from your Social Security check or pension. This will help you avoid tax penalties for underpayment of your tax liability when you file your tax return.
• Decide on a tax-efficient retirement strategy. You might want to withdraw money from taxable accounts first, giving your tax-deferred accounts more time to grow. Talk to a financial advisor about your overall retirement income strategy and how taxes affect your plans.

 

Sources:

Footnotes

^1. https://www.businesswire.com/news/home/20180618005207/en/Divorce-compounds-retirement-risk

 

Ben Granis a freelance writer based in Des Moines, Iowa. He writes about personal finance, financial services, technology and business.

 

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