New Baby, New House or New Spouse? How Major Life Changes Affect Your Taxes
Getting married? Having a baby? Buying a house? These life changing events are more than just momentous occasions; they have major tax implications. Miranda Marquit of Planting Money Seeds outlines some of the biggies below — and explains what they could mean for your tax bill.
Any time you experience a major life event, you need to consider the tax implications. Major changes in your situation can mean a difference in your tax bill. Here are 5 life events that can impact your tax return:
When you marry, you can file jointly. This can provide you with an advantage on your taxes, since it can mean that your tax bracket is lower than when you were single. Additionally, filing jointly while married can mean a better opportunity to take advantage of credits and deductions with phaseouts.
Another big change is divorce. Now that you’re filing as single, you’ll need to make sure that dependents, credits, and deductions are properly divided between you and your former partner. Also, be aware of the “head of household” option. If you are unmarried at year’s end and support a dependent for more than half of the year, you can choose this option. You’ll need to carefully evaluate your new situation to determine how your tax bill will change.
Now that you have a baby, you can take advantage of new tax breaks. You can claim your child as a dependent, and, if you meet the income requirements, your child makes you eligible for the additional child tax credit. You might also qualify for the Earned Income Credit (EIC). This is a credit designed to help low and middle income earners reduce the burden associated with Social Security taxes. The EIC is also associated with having qualifying children and meeting income requirements.
If you adopted your new baby, there’s a generous adoption tax credit. Make sure you have the qualifying child’s Social Security number.
Buying Your First Home
One of the things I noticed when we bought our home is that the large new deduction for mortgage interest resulted in a tax refund. If you itemize, you can claim the mortgage interest you pay, as well as property taxes and (for a limited time) PMI premiums.
If you refinance, look into how you can deduct points paid for this effort.
Losing Your Job
With lower income, you might find yourself in a lower tax bracket, as well as eligible for more credits and deductions that come with phaseouts. However, you should realize that you will be taxed on your unemployment benefits. They count as income, so you might be surprised to owe taxes – even if you have spent a good portion of the year unemployed.
As you transition into retirement, there are a number of tax issues you need to be aware of. First of all, if you retire early and tap your retirement account before age 59 ½, you are subject to an early withdrawal penalty.
As you begin taking distributions from your retirement account, it can affect your tax bill. Distributions from Traditional IRAs and 401(k)s are considered regular income, so you will pay taxes. (This is on top of the IRS charge for early withdrawal, if applicable.)
Earnings from Roth accounts, though, aren’t taxed when you withdraw as long as you wait five years after you made the initial Roth contribution and are older than age 59 1/2. As a result, many retirees like the idea of rolling their Traditional retirement accounts into Roth accounts. When you do that, though, you have to pay your taxes all at once on the amount you move over, since it is considered a distribution.
Don’t forget about Required Minimum Distributions (RMDs) that come when you turn 70½. For every qualified, tax-advantaged account except a Roth IRA, you have to take a certain distribution each year. Once again, rolling your money into a Roth IRA can help you avoid this requirement, but you will take a tax hit.
No matter what major life change you are experiencing, there is likely to be a tax consequence. If you aren’t sure how your next milestone will affect your situation, consult with a knowledgeable tax professional for more information.
Editor’s Note: This article was updated on August 3, 2016.