Who Claims the Kids When a Single Parent Dies Mid-Year? Part 2

Tax situations often turn into complex mazes.
Tax situations often turn into complex mazes.

Here’s the scenario and question I pondered in Part 1:

Husband and wife have 4 kids. The wife passes away. Five years later, the husband unexpectedly dies.

Two of the kids are adults in their 20s, but the other 2 kids are teenagers under the age of 18 and still in high school. The oldest 20-something gets custody of the teens.

In the year the father died, who claims the teens: the deceased father on his final tax return, or the eldest adult child who now has custody?

Analysis: Qualifying Child or Qualifying Relative?

Both of the teens are clearly still qualifying children. They’re under age 19 and still in high school. So, we’re going to look at the qualifying child rules to see what tax law can tell us about this situation.

Qualifying Child: Step-by-Step

Rule 1: The child must be the taxpayer’s child, grandchild, brother or sister.

Advantage: Tie. Both the deceased father and the eldest adult child meet this rule.

Rule 2: Must live with the taxpayer more than 1/2 of the year.

Advantage: It depends. See further discussion below.

Rule 3: The child is under age 19 at the end of the tax year, or under age 24 if a college student.

Advantage: Tie. The teens are under age 18 and still in high school. They clearly meet this rule and it doesn’t play into our analysis.

Rule 4: The child must not provide more than 1/2 of THEIR OWN support.

Advantage: Tie. Note that the rule states that the child cannot provide more than 1/2 of their own support. For our analysis, it doesn’t matter if the deceased father or the eldest child provided more support. Also, for our analysis, assume that the teens didn’t provide more than 1/2 of their own support.

Rule 5: The child is not married.

Advantage: Tie. The teens are not married.

Analysis: It All Comes Down to the Abode Test

The tiebreaker here is, who did the teens live with for more than 1/2 the year. Which means, it depends on when the father died.

If he died in the first half of the year (before July 1st), then he couldn’t claim the teens on his final return because they didn’t live with him more than half the year.

If he died in the last half of the year, then ONLY he would be entitled to claim the teens, because they would have lived with him more than half the year.

Marriage in the Tax Code, Part 13: Examples of the Marriage Penalty in the Early 1970s

wedding-rings-150300_1280Here are some examples of the marriage penalty that came about in 1971.

Us tax pros generally say the marriage penalty doesn’t apply at the lower ends of the tax brackets. That’s generally true now, and it was generally true in 1971. A typical middle class couple would not face the marriage penalty.

Example

In 1971, John and Jane are unmarried. John has taxable income of $8,000. Jane has taxable income of $1,000. John’s tax liability will be $1,590. Jane’s will be $145. Combined, that equals $1,735.

Now let’s say John and Jane are married. The tax on a joint tax return showing $9,000 of taxable income is $1,600. There is no marriage penalty at their income level.

($1 in 1971 is equal to $5.67 today. So $9,000 of income is approximately $51,000 today.)

Then as now, the marriage penalty applied mainly to cases where a couple both had taxable income.

Example:

In 1971, John and Jane have taxable income of $8,000 each (equal to about $45,000 each today) for total taxable income of $16,000 on their joint tax return. The tax on $16,000 for a married couple is $3,260.

If they were unmarried and filing as two single people, they would owe $1,590 of taxes each, or $3,180 of total taxes. That’s a marriage penalty of $80, or about $450 in today’s dollars.

Through the years, the marriage penalty would get worse, as we’ll explore in Part 14.

Who Claims the Kids When a Single Parent Dies Mid-Year? Part 1

Tax situations often turn into complex mazes.
Tax situations often turn into complex mazes.

Real-life scenario:

Husband and wife have 4 kids. The wife passes away. Five years later, the husband unexpectedly dies.

Two of the kids are adults in their 20s, but the other 2 kids are teenagers under the age of 18 and still in high school. The oldest 20-something gets custody of the teens.

In the year the father died, who claims the kids: the father on his final tax return, or the eldest child who now has custody?

Analysis

First, let’s look at what tax law says. 

Section 152 of the Internal Revenue Code defines the term “dependents.” A dependent falls into one of two categories:

  1. A qualifying child, or
  2. A qualifying relative

Qualifying Child

A qualifying child is:

  1. A taxpayer’s child, grandchild, brother, sister, step-brother or step-sister
  2. Lives with the taxpayer more than 1/2 of the year
  3. Is under age 19 at the end of the tax year, or under age 24 at the end of the tax year if the child is a student
  4. A child who does not provide more than 1/2 OF THEIR OWN support
  5. The child is not married, or if they are married, does not file a joint tax return with their spouse (except in certain cases involving the earned income credit).

Qualifying Relative

A qualifying relative is:

  1. Someone whose gross income is below the personal exemption amount for the year (for example, below $3,950 in 2014)
  2. The taxpayer must provide more than 1/2 of the person’s support
  3. The relative cannot qualify someone else’s qualifying child

Additionally, someone who’s not a blood relative must live with the taxpayer all year in order for the taxpayer to claim that person as a dependent.

In Part 2, I’ll analyze how this applies to the scenario posed at the beginning of this post.

Image courtesy of user OpenClips on Pixabay.com

Marriage in the Tax Code, Part 12: Meet the Marriage Penalty

wedding-rings-150300_1280Of all the tax myths that exist, the one I encounter most is: married couples always save money on their taxes.

But since 1971, this has not been true.

As I’ve detailed in prior parts of this series, tax law regarding marriage has changed through the years. In the beginning, there were no filing statuses and only one tax bracket. Marriage conferred no benefits but also no penalties.

Married couples in community property states soon discovered that they could save money by employing community property laws to split income. This created an inequality between married couples in community property states and married couples in common-law states.

To fix this inequality, Congress created filing statuses with unique tax brackets in 1948. But in fixing this inequality, a new inequality was created, this time between married couples and unmarried couples.

Congress made fixes in 1969 (which took effect in 1971) to try and fix this inequality. Instead, the tax brackets created the “marriage penalty,” which historically has affected 50% of married couples.

Stated simply, the marriage penalty is when two people are better off filing as two single (unmarried) people rather than filing as a married couple.

In future parts, we’ll look at examples of the marriage penalty since 1971 and examine more closely the social and legal landscape that led to the marriage penalty phenomenon.

Same-sex Marriage and Paycheck Withholdings – An Unpleasant Surprise on 2014 Tax Returns

Image courtesy of user Nemo on Pixabay.com
Image courtesy of user Nemo on Pixabay.com

A trend I noticed this year with my clients who are in same-gender marriages: an unpleasant surprise at tax time because of changes to their paycheck withholdings in 2014.

Some of my clients went from getting a refund of several-thousand dollars in prior years to owing several-thousand dollars on their 2014 tax return.

What’s Going On?

(For all of these examples, I am using the withholding tables in Publication 15 for 0 exemptions.)

This issue has everything to do with how much income tax is withheld from a person’s paycheck. Contrary to what the H&R Block and TurboTax commercials imply, there’s no magic that a preparer can work to give people a bigger refund — tax refunds are almost always determined by how much tax was withheld from wages during the year.

With paycheck withholdings, there are two withholding options: single or married. More taxes are withheld under the single rates than the married rates. Note: this refers only to how much tax is taken out of paychecks, not to how much tax a person will owe on their tax return.

Here are examples of how this affects couples in same-sex marriages:

EXAMPLE 1

Lloyd and Floyd are married. In 2013 (the year the Supreme Court struck down the Defense of Marriage Act), Lloyd and Floyd’s employers considered them single for withholding purposes and withheld at the single rates.

Lloyd makes $1,000 per payday and is paid twice a month. Floyd makes $2,000 per payday and is also paid twice a month. Assume that they claim 0 exemptions.

Using the withholding tables in IRS Publication 15, Lloyd will have $118 withheld from his paycheck each payday ($2,832 per year) and Floyd will have $303 withheld each payday ($7,272 per year). Total withholding between the two of them is $10,104.

Let’s assume Lloyd and Floyd file as married in 2013, using the standard deduction. No kids, no credits, etc.

Their gross income is $72,000. Exemptions of $3,900 each = $7,800. The standard deduction for a married couple in 2013 was $12,200. Their taxable income is: $72,000 – $7,800 – $12,200 = $52,000. The tax owed on $52,000 by a married couple in 2013 was $6,911.

Lloyd and Floyd would have received a refund of $3,193. ($6,911 tax liability minus withholding of $10,104.)

EXAMPLE 2:

Now it’s 2014. The employers of both Lloyd and Floyd have now switched to withholding at the “married” levels.

Now Lloyd has $68 withheld each paycheck ($1,632 per year) and Floyd has $216 withheld each paycheck ($5,184 per year). Total withholding is $6,816.

Their gross income remains $72,000. Exemptions nudged up to $3,950 each = $7,900. The standard deduction for a married couple in 2014 is $12,400. Their taxable income is: $72,000 – $7,900 – $12,400 = $51,700. The tax owed on $51,700 by a married couple in 2014 is $6,851.

Since their withholding dropped by so much, they end up owing $35 dollars this time around: a swing of more than $3,200.

Note that their tax liability actually dropped slightly in 2014, but they still end up owing because of the big shift in withholding.

With some of my clients this year, the shift resulted in them owing thousands of dollars.

SOLUTION

Married people can elect to have their withholding come out at the single level, and that’s the best thing to do if a couple in a same-gender marriage finds themselves owing thousands of dollars at tax time.

In Lloyd and Floyd’s case, they could also choose to leave things as-is, as owing $35 means they nailed their withholding exactly right during the year … but that’s another topic for another day.