Tax Planning Basics: Major Life Events And Tax Implications
The amount of tax that you are liable to pay to the Internal Revenue Service (IRS), the government agency tasked with collecting taxes, varies with your level of income. But your tax liability is also influenced by several other factors.
Getting married may reduce the amount of tax that needs to be paid. Similarly, if you have a baby, you could claim certain tax benefits.
Outlined below are brief descriptions of several, common major life events and how they may affect your tax liability:
Once you are married, filing jointly can provide several benefits. You will get the advantage of a higher standard deduction as well as the opportunity to claim other deductions in addition to certain credits.
Joint filing qualifies you for Child and Dependent Care Credit, Tuition and Fees Deduction and the earned income tax credit (EITC). The EITC is a tax credit that subsidizes low-income working families.
When you get married, you should review your withholdings from your paycheck. Your W-4, which is the Employee’s Withholding Allowing Certificate, may change as your combined income could alter your tax bracket.
However, filing jointly may not always be the best option. Consider a situation where one of you owes back taxes. If you file jointly, any refund that is due would be adjusted.
Having a Baby
Each child in your family entitles you to an exemption of $4,050. This amount can be deducted from your Adjusted Gross Income when you file your return.
According to IRS rules, this deduction is available for your child or stepchild as well as for a foster child, a sibling or step-sibling, even a grandchild. But there is an age limit that is applicable. The child must be under 19 at the end of the year. If the child is a full-time student, the age limit is relaxed to 24.
Another condition that must be satisfied is that the child should not provide more than half of his or her support. So, if the child is earning a certain amount, this exemption may still be available.
For example, if you have three children, you could be eligible for a total deduction of $20,250. That’s $12,150 ($4,050 X 3) for the three children and an additional $8,100 ($4,050 X 2) as a personal exemption for you and your spouse.
Student Loan Interest Deduction
If you are paying off a student loan, you may be allowed to reduce the interest component from your income. This exemption is only available if your income is below a certain limit.
The loan that is being repaid should have been taken for you, your spouse, or a person who was dependent on you at the time that the funds were borrowed. Even if this condition is met, you may still not get the exemption if the loan was taken from a related person or under the terms of a qualified employer plan.
There are other conditions as well. The loan should have been utilized for one or more of the following expenses:
- Tuition and fees.
- Room and board, subject to certain limits.
- Books, supplies, and equipment.
- Other necessary expenses such as transportation.
The money that you have put into your retirement account could be subject to tax when you withdraw it. But this rule does not apply to all types of retirement accounts.
It is important to understand the difference between a traditional Individual Retirement Account (IRA) and a Roth IRA. (The Roth IRA is named after late Senator William Roth of Delaware.)
When you contribute to a traditional IRA during your working years, you get a tax deduction for the amount that you deposit. Subsequently, the amount grows on a tax-deferred basis. This means that you don’t need to pay any tax on capital gains. But when you start making withdrawals, the amount will be taxed.
That’s how a traditional IRA works. A Roth IRA operates differently. You don’t get a tax break for the funds that you deposit. But when you withdraw, the sums are tax-free.
Tax on an Inheritance and Estate Tax
If you receive an inheritance, it will usually be tax-free. But this is not true for all inheritances. For example, you may receive an IRA as part of an inheritance. The money that you withdraw from the IRA account could be taxable.
It is also important to know the difference between an inheritance tax and an estate tax. The former is paid on the basis of an individual bequest of property, but estate tax is calculated on the overall value of the deceased person’s assets.
Don’t Forget Your Tax Deadlines
You need to file your tax returns every year. The deadline for filing for 2017 is April 17, 2018. But if you need more time, you can apply for an extension. This application for an extension needs to be filed by April 17 as well but will give you time up to October 15, 2018, to file your returns.