Cohabitation tax implications: when family doesn’t make a ‘tax family’

October 23, 2014 : Annelise Wiens

Families come in all sizes, but the IRS has very specific definitions about who makes up a “tax family.” For the growing number of unmarried couples who are co-parenting, this means they can’t both claim their children as dependents (and reap the subsequent tax benefits). Instead, the couple will choose who gets to claim each child and their benefits. There is usually one best way to divide up the children and their tax benefits that results in a better overall tax outcome for the entire family.

“If you’re trying to get the best possible tax outcome overall, you shouldn’t arbitrarily split up your kids’ benefits by alternating years or each parent claiming one child if you have two. There usually is a best way that will lower your combined taxes the most,” said Jackie Perlman, principal tax research analyst at The Tax Institute at H&R Block. “And, it could very likely change each year as your income and child care and education expenses change, or as your family size changes as you have more children or your kids grow up and move out.”

Not an ancient Solomonic quandary, just a tax question: how to split the children?

While unmarried couples can choose who may claim each child, they can’t claim the same child. If they have more than one child, they can split the children how they want but cannot divide a child’s tax benefits. So a couple with three children could have one parent claim all three, or one parent claim two and the other parent claim one.

If the parents can’t decide who will claim their children, tax law dictates the person with the higher adjusted gross income will claim them.

“Taxes are going to be even more complex for unmarried parents with more than one child. But, they should not shy away from mastering this complexity. If they understand what tax rules apply, run the numbers and estimate their taxes before filing, they will achieve a better tax outcome,” said Perlman.

To figure out which filing option gives them the best outcome, the couple will need to know the different child tax benefits available, how they interact with other tax provisions and how they fit their situation.

Although there are no dependent exemptions starting in 2018, whoever qualifies to claim the child will also potentially qualify for child-related tax benefits. These benefits include head of household filing status, the $2,000 child tax credit, the $500 non-child tax credit, the credit for child and dependent care expenses and the earned income tax credit – in total worth thousands of dollars in potential tax breaks.

Imagine a couple with one parent earning significantly more than the other does. The higher-income parent may want to claim the child to use head of household filing status and get a higher standard deduction, and so lower their taxable income and tax rate. However, the lower-income parent may want to claim the child to claim the earned income tax credit and get a larger refund.

“In this example, either arrangement may be to the parents’ overall advantage, which is why it’s so important to run your specific numbers through different scenarios, to make sure you’re getting the outcome that works best for you,” said Perlman.

Filing status options for unmarried parents

Rather than both parents using the single filing status, which will limit certain tax benefits, one of the parents will likely qualify to file as head of household. Filing as head of household will increase that parent’s standard deduction from $12,000 (for single filers) to $18,000 and will usually lower their tax rate.

To file as head of household, the parent must pay more than half the cost of household expenses and maintenance for the year. This means that for unmarried couples with one income, generally, only the parent earning an income or who has other sources of funds will be able to use the head of household status.

Cohabiting couples’ tax credits and deductions

Unmarried parents get the same tax benefits – and “no sharing” rules – as married taxpayers, but the qualifications and income thresholds may differ.

Standard deduction

The standard deduction reduces taxable income, which in turn reduces taxes. Single filers get a $12,000 standard deduction, but it increases to $18,000 for head of household filers. The married filing jointly standard deduction is $24,000, which means an unmarried couple where one parent qualifies for head of household and the other files as single will get a combined standard deduction $6,000 greater than if they were married. However, their tax brackets may not be as favorable as the married filing jointly status, so the overall impact could be different.

Child tax credit

The child tax credit is worth up to $2,000 for each qualifying child and reduces taxes dollar for dollar. For married couples filing jointly, the benefit begins phasing out at $400,000 of income. For all other filers, it begins phasing out at $200,000.

“The new phase-out thresholds for the child tax credit are so high that most parents won’t be impacted, but for very high-income unmarried parents, it could give them a way to qualify for the child tax credit they wouldn’t be able to if they were married. For example, if one parent earns $300,000 and the other earns $150,000, they would be phased out of the credit if they were married. But the parent who earns $150,000 would still qualify for the credit as a head of household filer and would get that benefit,” said Perlman.

Child and dependent care credit

Working parents may claim a child and dependent care credit for up to 35 percent of qualifying child care expenses. It is capped at $3,000 of expenses for one child or $6,000 of expenses for more than one for all tax filing statuses.

“The child and dependent care credit can get interesting for unmarried parents with three or more children. Although the max is $6,000 expenses for more than one child, if you claim two children using $6,000 of expenses and your partner claims one child using $3,000 of expenses, you get a combined benefit of up to 35 percent of $9,000,” said Perlman. “That option isn’t available for married parents.”

Child and dependent care pre-tax benefit

Similar to the credit, the child and dependent care benefit helps offset qualifying child care costs. In this case, the parent can save up to $5,000 pretax in an employer-sponsored flexible spending account (FSA) to use toward child care expenses. This means parents in the 24 percent tax bracket could reduce income taxes by $1,200 by fully funding their FSA.

Earned income tax credit

The earned income tax credit (EITC) is for working, lower-income taxpayers. For married couples filing jointly with one child, they can earn $46,010 before losing eligibility for the credit. Other taxpayers with one child are limited to income of $40,320. The income limits increase as the number of children increases.

The benefits of filing jointly – if married

Married couples can claim their children and related tax benefits by filing jointly, but some married couples choose to file separately. Married couples who file separately, like unmarried parents, have to choose who claims the children. For 2018, the spouse who claims the child claims the tax benefits associated with the child, like the child tax credit and the child and dependent care employer benefit (although the maximum amount is half the normal allowed). However, each spouse can claim the medical expenses that they paid for their child, if they’re itemizing deductions.

However, married couples filing separately are excluded from claiming some tax benefits altogether. For example, the credit for child and dependent care expenses is normally not available for married couples filing separately, while the EITC is never available to these couples.

“Although the rules around splitting your children’s benefits add complexity to your returns if you’re unmarried parents, they also introduce opportunities that married parents might not have to shift income and benefits to get the best outcome. It doesn’t necessarily mean that you’ll get a better overall tax outcome if you stay unmarried, because the married filing jointly status has more favorable tax rates and brackets, but it means you have more options to consider and navigate,” said Perlman.

For help navigating those options, Perlman suggests unmarried parents visit a tax professional to talk about their unique situation.

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Annelise Wiens

Annelise Wiens

Editor and Producer

As the newsroom editor, Annelise Wiens is interested in more than just tax and industry news, but the stories of H&R Block's 80,000 associates, their communities and H&R Block's world headquarters in Kansas City, Missouri. Wiens joined H&R Block in 2014 from a public relations agency, where she worked with clients in the financial services industry. Before that, she worked as a communicator for a senior member of the United States House of Representatives. She graduated from Biola University in La Mirada, CA with a bachelor's degree in history.

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