Tax Guide for Women Who've Had a Major Life Change

Bridget Handke, CFP®, CAP®
Feb 29, 2024 11:09:16 AM

Life is full of twists and turns, and we may find ourselves facing significant life changes that impact our financial well-being. These events often have significant tax implications, whether it's marriage, welcoming a new baby, going through a divorce, losing a spouse or dealing with illness. Many women feel overwhelmed by the complexities of the tax system. This guide aims to provide a helpful resource for women navigating the tax landscape during these pivotal changes.

Marriage: The Union of 2 Financial Worlds

Getting married is a major milestone that may mean merging two financial lives. Newlyweds may want to consider:

Change in Tax Bracket: Your tax bracket may change as a married couple. Typically, married couples file jointly, resulting in a lower tax rate than when you were single.  

Filing Status: You can choose to file jointly or separately. In most cases, filing jointly is more beneficial, but it's essential to calculate both options to see what works best for your specific situation.

Tax Credits: Marriage can open the door to various tax credits and deductions, such as the Earned Income Tax Credit (EITC) and the Child Tax Credit, both of which can reduce your tax liability.

Example: Meet Sarah and James, a newlywed couple. Sarah earns $40,000 per year, while James earns $60,000. When they filed as single individuals, they were in the 22% and 24% tax brackets, respectively. As a married couple filing jointly, they're now in the 22% bracket, resulting in a lower overall tax bill.

Tips for newly married couples to ensure a smooth start on their financial journey:

  1. Update Withholding: Adjust your withholding allowances with your employers to ensure you pay the right amount of taxes throughout the year.
  2. Choose the Right Filing Status: Consider whether filing jointly or separately will benefit your financial situation more, and select the appropriate filing status.
  3. Explore Tax Credits: Consider tax credits available to married couples, such as the Earned Income Tax Credit (EITC) and the Child Tax Credit, to reduce your tax liability.
  4. Update Beneficiaries: Review and update the beneficiaries on financial accounts and assets to align with your marital status and current wishes.
  5. Update Your Address: Notify relevant agencies of your change in marital status and, if appropriate, your updated address to ensure you receive important tax documents and correspondence.
  6. Maximize Tax-Advantaged Accounts: Make the most of tax-advantaged accounts like 401(k)s, IRAs and HSAs to reduce taxable income and secure your financial future.
  7. Communicate About Finances: Maintain open and honest discussions with your spouse about your financial goals, budgets and tax strategies.

    Learn more: The most important money conversations to have with your spouse/partner.

  8. Keep Track of Deductions: Keep records of tax-deductible expenses such as mortgage interest and charitable contributions. Itemizing deductions may help to lower your tax bill.
  9. Seek Professional Advice: Don't hesitate to consult with a tax professional or financial advisor, especially if your finances are complex.
  10. Estimate Taxes on Additional Income: If you earn income without tax withholding, like freelance work or rental income, remember to make estimated tax payments to avoid underpayment penalties.
  11. Claim Student Loan Interest Deductions: If you have student loans, remember to claim deductions for the interest paid, subject to income limits.

Keeping these key points in mind, newly married couples can confidently navigate their financial journey and make informed decisions to secure their financial future together.

Welcoming a Baby: Tax Benefits of Parenthood

The birth of a child brings numerous joys and responsibilities. New parents should consider:

Child Tax Credit: You may be eligible for a Child Tax Credit of up to $2,000 per child in 2024. This credit, which applies for qualifying dependents under the age of 17, can reduce your tax liability. The credit decreases if your modified adjusted gross income exceeds $400,000 (married filing jointly) or $200,000 for all other filers. As of this writing, there is a pending bill in Congress that could expand this credit.  

Child and Dependent Care Credit: If you're paying for childcare while working or looking for work, you may qualify for this credit, which can offset some of your childcare expenses. In 2024, this credit is $3,000 for one qualifying individual and $6,000 for two.  

Dependent Care Flexible Spending Account (FSA): An FSA allows you to contribute pre-tax dollars through payroll deductions not subject to state and federal taxes. The withdrawals are tax-free if you use them for eligible expenses, such as daycare, preschool and day camps, as well as before and after school care programs. The amount is $5,000 per household or $2,500 for married filing separately.  

A family can contribute to an FSA and use the Child and Dependent Care Credit, but they cannot double dip by using the same dollars.  

Earned Income Tax Credit (EITC): The EITC assists low-to-moderate-income families, including those with children. The amount of the credit varies based on income and the number of qualifying children. The lower the income, the more the credit.  Here is a link to a table for this credit.

Adoption Tax Credit: If you've recently adopted a child, you may be eligible for a tax credit to cover qualified adoption expenses, such as adoption fees, court costs and travel expenses. The maximum for 2023 is $15,950 and $16,810 for 2024. However, income limits do apply. 

Education Credits: While your child may not be in school just yet, it's essential to be aware of education-related tax credits, such as the American Opportunity Credit and the Lifetime Learning Credit for future use.

Health Savings Account (HSA) Deductions: If you have an HSA, you can use pre-tax dollars to cover eligible medical expenses for you and your child, which can provide tax savings. The maximum HSA contribution in 2024 is $4,150 for individuals and $8,300 for families. There are no income limits. Funds going into an HSA are tax-free and funds withdrawn for qualified expenses are withdrawn tax-free.  

Example: Jane and Mike recently had a baby boy. They both work full-time. Additionally, they qualify for the Child Tax Credit, which provides a welcome financial boost to their family budget. Jane’s employer offers a Health Savings Account and a Flexible Spending Account. They contribute the maximum to both, reducing their income while also reducing their taxes. Because their daycare is expensive, they can also use the Child and Dependent Care Credit, which helps offset some of the daycare expenses. 

Other Items to Keep in Mind:

  1. Keep Track of Childcare Expenses: If you're eligible for the Child and Dependent Care Credit or contribute to an FSA, keep detailed records of all childcare expenses, including receipts and provider information.
  2. Adjust Withholding Allowances: Review the withholding allowances on your Form W-4 to ensure you're withholding the correct taxes from your paycheck. Overwithholding can lead to less take-home pay.
  3. Save for Education: While not an immediate concern, you may want to begin saving for your child's education early to maximize the benefits of education-related tax credits in the future. College 529 plans can be an excellent tax-advantaged way to save for college. 

    6 Benefits of a 529 Plan When Saving for College

  4. Seek Professional Guidance: Tax rules are complex, especially with life changes like having a child. Consult with a tax professional or financial advisor to maximize your tax benefits and avoid potential pitfalls.

Being aware of available tax credits and deductions can help new parents make the most of these financial opportunities and avoid common mistakes, while providing their child a secure and nurturing environment.

Divorce: Navigating the Financial Landscape

Divorce is a challenging life event, and it's essential to understand the tax implications to protect your financial future:

Filing Status: After a divorce, your filing status will typically change from married to single. However, if you provide more than 50% of the financial support for a child, you may qualify to file as Head of Household, which has more favorable tax rates.

Alimony and Child Support: Alimony is not tax-deductible for the payer nor is alimony taxable income for the recipient. Child support follows the same tax rules.

Property Division: The division of assets and liabilities can have tax consequences. Consult with a tax professional to navigate this process wisely.

Qualified Domestic Relations Order (QDRO): This court order requires a portion of a retirement plan to be assigned to another person through a divorce. When done correctly, withdrawals from a retirement plan via a QDRO can avoid a 10% penalty if you are under the age of 59 ½. The timing and sequence of events is important to avoid the penalty. We suggest seeking professional advice before a divorce is final. Note that even if you avoid a penalty, withdrawals from retirement plans are subject to income tax.     

Example: Lisa recently went through a divorce and has custody of her two children. Since she provides over 50% of their support, she can file as Head of Household instead of Single. This change in filing status can result in lower tax rates and a more favorable financial outcome. In her divorce, Lisa negotiated a QDRO of her ex-spouse’s 401k and was able to withdraw funds penalty-free to provide a down payment on a new home.   

Things to Consider:

  1. Filing Status: Determine your new tax filing status. You will typically switch from Married Filing Jointly to Single or Head of Household in the year your divorce is finalized.
  2. Property Division and Capital Gains: Be aware that the transfer of property between spouses as part of a divorce settlement is generally tax-free. However, consider any potential capital gains taxes when you sell assets in the future.
  3. Dependency Exemptions: Determine who will claim dependency exemptions for children. This will impact tax credits and deductions, such as the Child Tax Credit or the Earned Income Tax Credit (EITC).
  4. Child-Related Tax Credits: Understand the availability and eligibility requirements of child-related tax credits, such as the Child Tax Credit and the Child and Dependent Care Credit.
  5. Social Security: If you were married for ten or more years, you may qualify for spousal Social Security if you remain unmarried and are at least 62 or older. If your ex-spouse is deceased, you may qualify for survivor benefits. Seek professional guidance for more information on Social Security benefit eligibility.
  6. Health Insurance: Consider health insurance coverage for both spouses and any children. COBRA and other options may be available.
  7. Tax Liabilities: Clarify the division of any existing tax liabilities with your spouse. In the divorce agreement, specify who is responsible for prior joint tax debts.
  8. Asset Valuation: Ensure that the valuation of assets, particularly those subject to division, is accurate. Over- or undervaluing assets can have tax implications.
  9. Tax Implications of Asset Division: Be aware that different types of assets are taxed differently. Qualified assets, such as retirement accounts, will be taxed as ordinary income when withdrawn. Non-qualified assets are taxed only on the account's growth and may be taxed at the more favorable capital gains tax rate. Roth IRAs are not taxed upon withdrawal if all the rules are followed. Understanding these differences is key to ensuring a fair divorce settlement and division of assets.  
  10. Documentation: Keep detailed records of all financial transactions, including the division of assets, payments of alimony or child support and any other financial agreements made during the divorce.
  11. Professional Guidance: Consult with a tax professional, such as a tax attorney, accountant specializing in divorce-related tax matters or a Financial Advisor with a Financial Advisor with a Certified Divorce Financial Analysis (CDFA) designation. They can provide tailored advice and help you navigate the complex tax implications of divorce.

Divorce is a complex legal and financial process, and the tax implications vary widely based on individual circumstances. Planning ahead and seeking professional guidance during the divorce process can help you make informed decisions that minimize the tax impact of divorce and protect your financial well-being. Making adjustments after the divorce is final is crucial to ensuring financial success.  

Loss of a Spouse: Transitioning to a New Tax Status

Losing a spouse is emotionally challenging, and understanding your tax obligations can be overwhelming:

Filing Status: In the year your spouse passes away, you can still file as Married Filing Jointly if you have not remarried. Some people can file as Qualifying Widow(er) for two years following the year of death. To qualify, you must be eligible to file as Married Filing Jointly in the year of your spouse’s death, not remarry, have a child who qualifies as a dependent, live with the child and provide for more than half their care for the year. After that, you'll need to change your filing status to either Head of Household or Single based on your circumstances.

Social Security Benefits: Depending on your age, your deceased spouse's working history and the age of your children, you may be eligible for Social Security survivor benefits. These benefits can provide crucial financial support during this difficult time. A widow can receive benefits at any age if they are taking care of a child who is younger than age 16 or has a disability. Working and earning income may affect this payout. Additionally, your unmarried children younger than age 18 may also receive survivor benefits.  

Asset Step-up in Basis: Depending on your state, nonqualified assets, such as your home and brokerage accounts, may receive a full or partial step-up in basis. The benefit is that when you sell the investment in the future, the cost basis is higher, lowering the growth and reducing your capital gains tax. We suggest working with your financial advisor to ensure the step-up is done correctly for your brokerage accounts. If you don’t plan to move from your home soon, we recommend hiring an appraiser to determine the value of the house at the time of your spouse’s death. Doing so could potentially reduce or eliminate any future capital gains tax. 

Life Insurance Proceeds: Life insurance proceeds are generally tax-free. There is no need to report them on your income tax return. Be sure to claim all the life insurance your spouse had. Many employers and some associations provide life insurance, so be sure to check with them. 

Example: Emily lost her husband, David, last year. This year, she can still file as Married Filing Jointly. Her 12-year-old child will receive Social Security benefits and Emily expects to file as a Qualifying Widow for the next two years. She and David purchased their house twenty years ago for $150,000. She hired an appraiser who estimated the current value of the house at $800,000. Since she lives in Minnesota, the cost basis of the house, following David’s death, is now $475,000 because 50% of the cost basis "steps-up" to the fair market value at date of death. That means 50% of the total basis is now $400,000 (50% of $800,000). The other 50% is Emily's original basis, which is $75,000 (50% of $150,000). If she sells the house in two years for $825,000 her gain is $350,000. If she is still single when she sells the house, the first $250,000 of the gain is excluded, so she will only pay capital gains tax on $100,000.  

Other Items to Consider: 

  1. Missing the Deceased Spouse's Income: Ensure that you report all income, including any income generated by your deceased spouse's assets and investments, on your tax return for the year your spouse died.
  2. Take Your Time Making Financial Decisions: Avoid making hasty financial decisions in the wake of your spouse's death. Seek professional advice before making any significant financial moves such as selling assets or investing.
  3. Update Beneficiary Designations: Review beneficiary designations on retirement accounts, life insurance policies and other assets to reflect your new circumstances.
  4. Remember Final Medical Expenses: Keep track of any unreimbursed medical expenses incurred during your spouse's final illness. These expenses may be deductible as itemized deductions.
  5. Meet Deadlines: Be aware of tax filing deadlines and any extensions you may need to request. Failure to meet deadlines can result in penalties and interest charges.
  6. Work With a Professional to Consolidate Accounts. As a widow, you have unique options in dealing with your spouse’s retirement accounts. Depending on your situation, you can choose to keep the accounts separate or roll them into your own. There are tax implications for both options so be sure to seek professional guidance.  

There are many financial changes and decisions to be made after a spouse dies. Not everything has to be done at once. It’s beneficial to work with an objective professional, such as a financial advisor, to guide you through the process and ensure deadlines are met. 

Download Our Guide: Finances for One - A Financial Guide to Managing Money for Widows

Dealing With Illness: Navigating Medical Expenses

Facing a severe illness is incredibly challenging, and it can also impact your tax situation:

Medical Expenses: You may be able to deduct unreimbursed medical expenses that exceed 7.5% of your adjusted gross income. Keep detailed records of all medical bills, prescriptions and related expenses.

Itemizing vs. Standard Deduction: Depending on the total amount of your deductible expenses, you may choose to itemize deductions rather than taking the standard deduction.

Tax Credits: Some medical expenses, such as long-term care insurance premiums, may qualify for tax deductions or, in some states, a tax credit.

Disability Income: Depending on your illness, you may be unable to work. If you had disability insurance, you may receive a payout. The disability payment may or may not be taxable. If you paid the premium (or if your company paid the premium but you paid the tax on the premium), your disability benefit would not be taxed. If your company paid the entire premium and didn’t tax you, the disability payment will be taxed. If you receive Social Security disability your benefits may be taxed, depending on your income. 

Tax-Free Withdrawals From Your Health Savings Account: If you have medical expenses, you can pay for these expenses using tax-free withdrawals from your Health Savings Account. You will need to match the expenses to the withdrawal.  

Example: Maria was diagnosed with a chronic illness that required frequent medical treatments and prescription medications. Her out-of-pocket medical expenses exceeded 7.5% of her income, allowing her to itemize her deductions and reduce her taxable income. She has not been working for the last six months. Because she paid the premium for her employer-offered disability insurance, she is not taxed on the payments.  

Major life changes can be daunting, but understanding how they affect your taxes can make a world of difference. Whether you're getting married, having a baby, going through a divorce, losing a spouse or dealing with illness, the key is to stay informed and seek professional advice when needed. By taking these steps, you can confidently navigate the tax system and ensure that your financial future remains secure during these life-altering events. Remember, you don't have to be a tax expert to make informed decisions – just a little knowledge can go a long way in securing your financial well-being.

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