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| The Basics | Cut your taxes from cradle to grave
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The big events in your life can save you money -- or cost you if you're not careful. Bone up on the tax implications of marriage, kids, divorce, retirement and you'll be a little wiser, a little richer.
By Jeff Schnepper
You get married. You have children. You buy a house. You send kids to college. Profound events all of them, and every one has tax implications. Add to that your financial birthdays -- ages reached that are financially significant because of tax or retirement reasons -- and you have a calendar of decisions to be made.
Heres a rundown of how your life and your taxes intersect.
Getting married
Lets start with the most glorious day of your life -- the day you are married! (My wife made me write that.) It's a day filled with tax consequences.
Well start simple. Theres probably going to be a name and/or an address change. Youll have to notify both the IRS and the Social Security Administration. Youll have to file Form SS-5 with Social Security Administration. Get it by calling 800-772-1213 or from the Social Security Administration's Web site. (See Related Web sites at left.) You can download IRS Form 8822 from the IRS's Web site or from MSN Money or you can call 800-829-3676.
Once youre married, you can no longer file taxes as single. Your marital status is determined on the last day of the year. So, if you marry on Dec. 31, the IRS considers you married all year. If youre divorced on Dec. 31, the IRS wont let you file jointly or as married filing separately.
BIG tax consequences! Once youre married, youre subject to either a marriage bonus or a marriage penalty.
You get a marriage bonus if only one of you works and earns a salary. Thats because you can now file jointly and the rates for joint filers are less than those for single filers.
For instance, in 2004, single filers are taxed at a 28% rate on income over $70,350. Joint filers dont reach that level until their taxable income is over $117,250. So, if Im the only one working and have a taxable income of $112,850, I save $1,321.50 in taxes if I marry before the year-end. Thats 3% of the difference between $117,250 and $70,350. The 3% represents the savings between the 28% bracket and the next lower bracket, 25%.
On the other hand, if both of you are working, theres a marriage penalty. Thats because when you file jointly, your spouses first dollar earned is taxed at your highest marginal rate.
For instance, if both you and your fiance had taxable incomes of $141,250, each of you would pay $42,640 for a total of $85,279 in federal income taxes. Filing jointly, your total taxable income would be (all other things unchanged) $282,500. The tax on that would be $74,250. By postponing a Christmas wedding until New Years, youd save $11,000 -- enough to put a real dent in that honeymoon bill!
To be sure, Congress gave married couples a small break in the 2003 tax bill -- expanding the standard deduction for married couples filing jointly to $9,700 in 2004 and $10,000 in 2005, exactly twice the standard deduction for single filers.
Filing married separately doesnt help. The IRS just cuts the joint numbers in half. But it may be the way to file if theres a floor, the 7.5% medical or the 2% on miscellaneous itemized deductions, that one spouse could meet but not both together.
Whether you get a bonus or a penalty, you might want to consider amending your W-4 to adjust the allowances to reflect your new potential tax.
Having kids
Now that youre married, you might as well put some real joy in your life! (My kids made me include this one!) Ask any parent if having a child has consequences.
But, lets look on the bright side.
Each child gives you an additional exemption deduction of $3,100 in 2004 -- $3,200 in 2005. If theyre under age 17, youre also offered a tax credit of $1,000 per child. A tax credit is a dollar for dollar reduction in your tax -- much better than a deduction. (A note: You start to lose the credit once your income exceeds $110,000 for joint filers and $75,000 for singles.)
The time to plan for kids is before you ever thought of having them. But, better late than never.
Once you have them, you must put aside money for their educations. Consider a Section 529 account if you want to save for their college expenses on a tax-exempt basis. In my opinion, that's the best way to go.
Consider a Coverdell Savings Account if you want to save for college or elementary and secondary school expenses on a tax-deferred basis. These are the old Education IRA accounts, but you can now contribute up to $2,000 a year. Make sure all Coverdell money is withdrawn by your named beneficiary by age 29, or name a new, younger beneficiary. Otherwise, the beneficiary will face ordinary income tax and a 10% penalty on her next birthday.
And dont forget: Coverdell accounts are subject to income restrictions, and high-income taxpayers are not eligible to use them. Annual income limit for full eligibility is $95,000 for single taxpayers and $190,000 for joint filers.
Lastly, shift some income to the kids. Until theyre age 14, theyll be subject to the kiddie tax. That means that if they dont have any earned income, the first $750 will come to each child tax free, and the next $750 will be taxed at their rate. All income over that will be taxed at your highest marginal rate.
A little savings until age 14. A lot of savings after that. Thats when all of their income is taxed at their rate . . . usually lower than yours.
Buying a house
Another big step. Now you probably will itemize your deductions rather than take the standard deduction. Your interest and property taxes will both be deductible. Remember to deduct any interest and taxes paid (not just put aside as a reserve) at closing that may not be reflected on any Form 1098s. Also, dont forget to take any points you paid at closing. You can amortize them over the life of the loan or deduct them all at once on Line 12 of your Schedule A.
When you sell the house, you can exclude as much as $250,000 in gain ($500,000 on a joint return) if it was your principal residence for two of the last five years. The old rules about replacing the house or being age 55 no longer apply. If you qualify, you need never buy another house to get the exclusion.
Divorce
You married, had kids and bought a house. Guess whats coming next for some people?
Half of all marriages end in divorce. Lots of financial and tax considerations.
Alimony. This is deductible to the paying spouse and is income to the spouse getting the dollars. Child support is neither deductible nor taxable. If you and your ex have different tax brackets, reclassifying child support into alimony may allow more to be paid with a smaller net after-tax cost to both parties. Its a win-win for all, except the IRS.
Equitable distribution of assets. This exercise has no tax consequences. Whoever gets the property takes the old basis of that property . . . and pays any tax when that property is sold.
Insurance and retirement beneficiaries. Change your insurance and retirement beneficiaries where appropriate. If youre splitting retirement benefits, make sure you get a special court order called a Qualified Domestic Relations Order (QDRO) or youre going to be taxed on dollars going to your former spouse. With a QDRO, the spouse receiving the money is the only one paying the tax.
Retirement
More tax considerations. Do you finance your retirement with tax-qualified deferred money like a 401(k) or traditional deductible IRAs, or do you use non-deductible but completely tax-free Roth contributions?
How old are you? At age 50, you can put more into your retirement plans. At age 55, you can avoid the 10% early withdrawal penalty on distributions from a qualified retirement plan or annuity if you leave your employer. Once youre 59 1/2, the 10% penalty no longer applies.
At age 62, you can start collecting Social Security at a reduced rate. As much as 85% of that income may be taxable, depending on your other income.
At age 70 1/2, you have to consider taking minimum distributions from your retirement plans. You can postpone the first distribution until the next year. But then youll have to take 2 distributions in that year. That may push your income higher and subject more of your Social Security to potential tax.
You can read more about retirement planning on MSN Money; click here to get started.
Estate planning
It's been said that the only two certainties in life are death and taxes. Almost every step you take during life has tax consequences. There are even significant tax consequences to you and your beneficiaries at death.
That's why estate planning is so important. You're going to need a will or a living trust to dispose of your assets. Some assets, such as retirement plans and life insurance, go as directed by their beneficiary designation, even if your will specifies a different beneficiary. Each state has its own rules for state inheritance taxes. And then there's the federal estate tax.
There's no federal estate tax if your estate is worth $1.5 million or less in 2004 and 2005. This "exclusion amount" increases until 2010, when it becomes unlimited.
But, we're talking about the IRS here. Die on Dec. 31, 2010, and you pay zero estate tax no matter how big your estate. Die on Jan. 1, 2011, the next day, and the exclusion amount is scheduled to drop down to $1 million again. (And who knows what Congress will do after that.)
That's why it's so important to sit down with a professional with this one. It doesn't affect just you, it affects those you love.
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