SOME TRULY BASIC TAX BASICS

Let me review some truly basic tax “stuff” – things that I would have thought everyone knows, but still get questions about.

(1) Your filing status for the tax year is determined by your status on the last day of the year – December 31^st. 

a. If you are legally married on December 31, 2019, even if your wedding was December 30, you must file your 2019 tax returns for as either Married Filing Jointly or Married Filing Separately. 

b. If you are legally divorced on December 31, 2019, you must file your 2019 tax returns as either Single or Head of Household.

(2) If a person is alive for at least one day of the year he/she is considered for tax purposes to be alive for the entire year, and receives all the appropriate tax benefits, whether a dependent or an independent filer, for the entire year. 

a. If your spouse passes away at any time during the year, including January 1st, you can file as Married Filing Joint for that year. 

b. If a child is born at any time during the year, including December 31st, you can claim that child as a dependent, with all the applicable tax benefits (Child Tax Credit, Earned Income Credit), for that year.  

c. If a child is born on May 1st and passes away on May 2nd you can claim the child as a dependent for that year.

(3) You will only receive a tax benefit for an expense or action that qualifies as an itemized deduction if you itemize your deductions by filing a Schedule A – if your total itemized deductions exceed the applicable Standard Deduction amount for your filing status and situation.

Charities advertise that you can get a tax deduction for donating your car to their organization.  This statement is true – but only if you are able to itemize. 

If you donate a car with a deductible value of $2,000 to, for example, Kars 4 Kids, and you are in the 22% federal tax bracket and -

a. you itemize on Schedule A, and the full amount of the $2,000 deduction is in excess of your Standard Deduction, you will put $440 in your pocket (plus any state tax savings).   $2,000 x 22% = $440.

b. your total allowable itemized deductions, including the $2,000 for the car, is $11,000 and your Standard Deduction is $12,200 (the Standard Deduction amount for a Single filer for 2019) you put absolutely nothing in your pocket – you get no tax benefit from donating your car to the charity.  $11,000 less $12,200 = $0.00.

c. your total allowable itemized deductions, including the $2,000 for the car, is $13,000 and your Standard Deduction is $12,200 you out only $176 in your pocket (plus any state tax savings).  $13,000 less $12,200 = $800 x 22% = $176.

The above item (3) is actually inspired by a true story from my practice.  Years ago, a client came to see me and was happy as a pig in reality tv.  She said she had donated her car to charity and was told she would get a big tax deduction.  She could not itemize, even the car deduction, and got zip.  Clearly, she was not pleased.

TTFN

  

DEPENDENTS AND THE 2018 TAX RETURN

Here are some things that taxpayers with dependent children need to know when planning for and preparing their 2018 federal income tax returns.

* For 2018 your dependent children can make up to $12,000 in “earned income” – W-2 wages and net earnings from self-employment - without having to pay any federal income tax.  This is based on the new Standard Deduction amount for a Single individual.  They will still need to file a federal tax return to get a refund of any federal income tax return or if they had “unearned income” such as interest, dividends and capital gains.

* The “Kiddie Tax” is no longer dependent on the income of the parents.  The taxable income of a child attributable to net unearned income is taxed according to the brackets applicable to trusts and estates.

The 2018 Tax Rate Schedule for Trusts and Estates are -

Taxable Income of:	Tax Due is:
$0 - $2,550	10%
$2,551 - $9,150	$255 plus 24% of amount over $2,550
$9,151 - $12,500	$1,839 plus 35% of amount over $9,150
$12,501 +	$3,011.50 plus 37% of amount over $12,500

The lower tax rates for qualified dividends and capital gains for Trusts and Estates apply as follows:

 0% =  $        0 - $  2,600

15% = $  2,601 - $12,700

20% = $12,701 and higher

Here is a basic example A dependent child has no earned income and $7,000 of interest and short-term capital gains – so none of the income is taxed at the special lower rate.  The Standard Deduction allowed is $1,050, so net taxable income is $5,950.  The amount of income subject to the Kiddie Tax is $4,900 ($7,000 less $2,100 threshold).  $2,550 is taxed at 10% = $255.  $2,350 is taxed at 24% = $564.  The remaining $1,050 is taxed at 10% under the table for a Single taxpayer = $105.  The total tax on $5,950 of net taxable income is $924 – an effective rate of 15.53%.  Under the “old” rules, with the income taxed at the parents’ rate, the Kiddie Tax would probably have been higher. 

* There has been no change to the rules for determining if a person can be claimed as a dependent on your 2018 Form 1040.

* While there no longer exists a Personal Exemption deduction amount, the amount of gross income used in determining if a person can be claimed as a dependent as a “qualifying relative” is what this amount would have been if it still existed – which is $4,150.

* There has also been no change to the rules for the Child and Dependent Care Credit.

Any questions?

TTFN

TAX ASPECTS OF DIVORCE

In the cover article of the Summer 2017 issue of the National Association of Tax Professionals’ quarterly TAXPRO JOURNAL I discuss in detail “The Tax Aspects of Divorce”.

 

The article includes the following statements –

 

“The U.S. Tax Code trumps the divorce agreement when it comes to who is able to claim a child as a dependent on the tax return.”

 

And –

 

“A local judge cannot overturn federal tax law.”

 

A reader sent me the following email in response to the article -

 

“The Tax Aspects of Divorce was very informative.  I do have a question, however.  In NATP’s Taxpro Journal it’s Page 13, first column, first paragraph.  The US Tax Code will trump a divorce agreement has been the way I was educated, but I’m a little confused about the last sentence in that paragraph which says ‘A local judge cannot overturn federal tax law.’  My understanding has been that the noncustodial parent who has been awarded the dependency exemption of the child can file a civil lawsuit against the now custodial parent to regain the dependency exemption.  That was verified by NATP & attorneys in my office. 

 

I’d appreciate it if you could just clarify that for me.”

 

Here is my reply to my fellow tax pro –

 

“Glad you found my article informative.

 

In answer to your question –

 

A non-custodial parent cannot claim a dependency deduction for a child unless the custodial parent provides a signed Form 8332.  The IRS will no longer accept the appropriate pages of a signed divorce agreement or decree with the exact same language as the Form 8332 as an alternative to a signed Form 8332.

 

It is my understanding that no divorce agreement or decree, and no local court judge’s decision or instructions, can force the IRS to allow the non-custodial parent to be able to claim a dependency exemption without a signed Form 8332.  A civil lawsuit award cannot in itself grant a non-custodial parent the dependency exemption.  Only a signed Form 8332 can grant a non-custodial parent the dependency exemption.

 

It is again my understanding that if a divorce agreement or decree says the non-custodial parent is entitled to the exemption, but the custodial parent does not provide a signed Form 8332, the “injured” parent can turn to a local court for relief and the court can require the custodial parent to provide a signed Form 8332 and penalize the custodial parent financially or legally for not doing so, or require the custodial parent to pay to the non-custodial parent the equivalent of the tax savings – but the local court cannot instruct the IRS to allow the non-custodial parent to claim the dependency exemption without a signed Form 8332.  

 

In my article I state –

 

‘If the divorce decree clearly states that the non-custodial parent is entitled to the deduction, but the custodial parent refuses to sign the Form 8332, the non-custodial parent must go back to the Court and get it to order the custodial parent to sign the form.  When negotiating a divorce settlement that gives the dependency deduction to a non-custodial parent there should be specific terms that require the signing of Form 8332 and outline what will happen if the custodial parent refuses to do so- such as the withholding of alimony payments or child support, or some other penalty.’

 

If you have any documentation or reference that indicates a local court can force the IRS to allow a non-custodial parent to claim a dependency exemption without a signed Form 8332 please let me know.”

 

As an aside – FYI the original article I submitted to NATP included the following paragraph in the beginning –

 

“Do you remember L.A. LAW?  While you would want Arnie Becker as the divorce attorney, the divorce agreement should be reviewed by Stuart Markowitz before it is signed.  For a more contemporary cultural reference - you would want David Lee as the divorce attorney, but have the final agreement reviewed by Will Gardner.”

 

However, despite my protest, this paragraph was deleted from the final published article.

 

So fellow tax pros – am I right?  Any thoughts and comments?

 

TTFN

 

 

 

 

 

 

 

WHY I WANT TO KNOW THE DATES OF BIRTH OF MY CLIENTS

I need to know the date of birth of all my 1040 clients, as well as that of their spouses and dependent children.

Why?  It is not that I am nosey.  And I do not send out birthday cards to all my clients.  There are several federal and state tax benefits and applications that take effect, or disappear, at certain ages.

Perhaps the most well-known age-based tax benefit is the additional Standard Deduction amount that is allowed for a person who is age 65 or older at the end of the year.  This additional Standard Deduction amount also applies to a taxpayer who is legally blind.  For 2016 the additional Standard Deduction amount for the age 65 or older or blind is $1,250 for married individuals and $1,550 for Single and Head of Household.

Back in “the day” a person turning age 65 would get an additional personal exemption, currently $4,050 for 2016 returns.  But this was changed to an additional Standard Deduction, effective with 1987 returns, via the famous Tax Reform Act of 1986.

One day back in the late 1980s, when I was still working occasionally with my mentor James P Gill at his storefront office in Jersey City during the tax season, while in the course of preparing the return for a woman Jim happened to say-

“Now be sure to tell us when you reach age 65.”

The client blushed, chuckled, and told Jim –

“I’m 70.”

The very next morning we hung a sign in the waiting area of the office that read “PLEASE TELL US WHEN YOU ARE AGE 65”.

Some states, including NJ, still provide an additional personal exemption for a person age 65 or legally blind.

You can take a distribution from a retirement account - like an IRA, SEP, or 401(k) plan – without having to pay a 10% penalty once you reach age 59½.  And some distributions from a qualified retirement plan (not an IRA) are penalty free once you reach age 55 or age 50.  In these cases the actual date of birth, and not just the year, are important.

If you are age 65 or older the AGI exclusion for medical expenses on Schedule A is 7.5 percent. This applies on a joint return even if only one spouse has reached 65. For those under 65, medical expenses are deductible only if they exceed 10 percent of AGI.  This applies for tax years through 2016 only.  For 2017 the 10% exclusion applies to all taxpayers.

It is important to know the date of birth of dependent children because –

ü  You can claim a exemption for a dependent child under age 19 at the end of the year, or under age 24 at the end of the year and a full-time student during any part of 5 months during the year, regardless of the amount of the dependent’s income.

ü  The Credit for Child and Dependent Care Expenses, and the pre-tax treatment of Child Care FSA payments, apply only to a dependent under age 13.  Here the actual date of birth is important, as the credit or exemption can be claimed on expenses incurred prior to the child’s 13^th birthday.

ü  The Child Tax Credit applies to dependent children under age 17 at the end of the year.

States also have certain age-based tax contingencies.  A NJ taxpayer who was 62 or older on the last day of the tax year may be able to claim a Pension Exclusion or Other Retirement Income Exclusion on the state return.  NY has an age-based “Pension and annuity income exclusion”.  NJ allows an additional personal exemption for a dependent child under age 22 at the end of the year who is a full-time student at “an accredited college or postsecondary institution”.  NJ requires that you enter the year of birth for all dependents on the NJ-1040, and NY requires the actual date of birth for all dependents.

The date of birth is also necessary to access needed state information online.  NJ asks for one’s date of birth to submit a return directly to the NJ Division of Taxation online, without using tax preparation software or a third-party, via the NJWebFile system, to download a Form 1099-G for state income tax refunds, to find out the amount of the NJ Homestead Benefit issued to a qualified homeowner, and to access a record of estimated tax payments.

So be sure that your tax professional knows your date of birth, the date of birth of your spouse, and the dates of birth of all of your dependents.

TTFN

THE NATP TAX FORUM AND EXPO IN PHILADELPHIA – PART II

At the NATP Tax Forum and Expo in Philadelphia last week I attended educational sessions on divorce, Schedule C, trusts, “wealthy” taxpayers, and current developments (of which there were really none, other than the inflation adjustments, that affect 2015 individual returns).  Here are some items of interest – not necessarily quoted from the sessions but “inspired” by items discussed in the sessions:

ü  In order to be claimed as a dependent as a “qualifying relative” your college student son or daughter over age 23, for whom you provide more than half of his or her support, must have gross taxable income of less than the current personal exemption amount.  For 2015 that is $4,000.  If that person’s only income is a W-2 reporting $3,942 in federal taxable wages it is ok – he or she is a dependent.  But if the total wages for the year are $4,009 he or she cannot be claimed as a dependent. In such a case $9.00 in income could cost you to pay at least $1,000 more in federal income tax.  So check on his or her wages at the beginning of December and tell him/her to stop working if he/she is already “close to the edge”.  You may even offer to reimburse him/her for lost wages if financially appropriate.

ü  The status of “custodial parent” is determined for tax purposes not by anything written in the divorce decree – but by the number of nights the child or children sleep at a parent’s home.  As with the per diem deduction for business travel the determining factor is where the child, or children, lay their heads each night.  A child may spend all day – from 8 AM to 8 PM - at the home of his or her father, but if he or she returns to the mother’s home at night to sleep that day is counted to the mother.  It is important that divorced parents keep a detailed “sleep log” for each child to be able to substantiate a claim of “custodial parent”.

ü  In order for a payment to be deductible as alimony it is important that the divorce decree or agreement states that the payment will cease upon the death of the recipient ex-spouse.  While it may be implied or obvious, it must be specifically stated in the document.

ü  If the father is paying for the qualified child care costs of a child or children, and running the costs through his employer-sponsored dependent care flexible spending account (such that his federal taxable wages reported on his W-2 are reduced by the $5,000 maximum), but the mother is the custodial parent, the father must add $5,000 to his taxable wages on Line 7 of his Form 1040 (or 1040A).  Even though the expenses are “qualified” and are paid by the father he is not entitled to the credit or pre-tax treatment.  When you think about it this makes sense (my thoughts, not those discussed in the session) – the credit or pre-tax treatment is allowed because the cost of child care is incurred so that the person caring for the child can work.  Even though the father is paying for the care, because the child does not live with him the purpose of the payment is not so he can work, but so the custodial mother can work.

ü  The “shared responsibility penalty” for not having sufficient health insurance coverage, which took affect with 2014 returns, is still with us – except that the penalty amount is increased – possibly doubled – for tax year 2015.  And beginning with tax year 2015 insurance companies and employers are required to issue Form 1095-B (insurance company) and Form 1095-C (employer coverage) to those covered by insurance as a way of verifying to the IRS, and the tax preparer, the months of “minimum essential” health insurance coverage.  A single taxpayer may receive multiple 1095-Bs and/or 1095-Cs for the year.  Form 1095-A will continue to be issued to those who purchased health insurance coverage via the Obamacare “Marketplace”.  Give all Form 1095s you receive – whether A, B, or C – to your tax preparer along with your 2015 tax “stuff”.

ü  While income from rental real estate is considered to be “passive income”, and subject to the 3.8% Net Investment Income surtax assessed on “wealthy” taxpayers, “self-rental” (renting real estate you own to your company) is not passive for Net Investment Income purposes and is not subject to the 3.8% surtax.

ü  A final reminder – the deadline for filing 2015 individual income tax returns, and automatic extension requests – is April 18, 2016.  The District of Columbia celebrates Emancipation Day on April 16 and when that date falls on a Saturday, Friday becomes the official date.  Therefore, since the term “federal holiday” includes any legal holiday observed in the District of Columbia, all taxpayers will now automatically get their due date extended to Monday April 18.  In Massachusetts and Maine Patriots Day is celebrated on the 3rd Monday in April, which is April 18 for 2016.  Therefore, taxpayers in these two states get to file and pay on Tuesday April 19. 

TTFN

CAN I CLAIM MY SON (OR DAUGHTER)?

As a veteran tax professional with 44 filing seasons under my belt and tax blogger one question I am often asked by clients, readers, and cocktail party guests is “can I claim my son, or daughter?”.

In order to be claim someone as a dependent on your tax return that person must be either a “qualifying child” or a “qualifying relative”. 

A qualifying child includes your child by birth, stepchild, or a foster child who is placed with you by an authorized agency or by judgment, decree, or other court order.  A child you have legally adopted is treated as your child by birth.

He or she must be either under age 19 at the end of the year or under age 24 at the end of the year and a full-time student for any part, even 1 day, of 5 months during the year.  A child is enrolled in an online or correspondence school does not qualify as a full-time student.  

The child must live with you as a member of your household for at least 6 months of the year.  If the child is temporarily at another location for a specific reason, such as in a dorm at college or in military service, he or she is still considered to be living with you.

A child who was born or who died during the year is considered to have lived with you for the entire year.  There is no limitation on the number of days – a child who passes on January 1, 2014, or is born on December 31, 2014, can be claimed as a dependent.

And you must provide more than 50% the child’s support for the year.  

A qualifying child who is married can only be claimed as a dependent if he or she does not file a joint tax return with their spouse, unless the only reason for filing a joint return is to claim a tax refund.

If a child is the “qualifying child” of both parents, who are separated, divorced or unmarried, there are “tie-breaking” rules for determining who can claim the child as a dependent.  Generally the child is the dependent of the “custodial parent”, which is the parent with whom the child lives with for the greater part of the year.  What is comes down to is the number of nights during the calendar year that the child sleeps at a parent’s home. 

You may also be able to claim your son or daughter as a dependent as a “qualifying relative”.  This happens if the child is over age 19, or 24, and has gross taxable income of less than the amount of the personal exemption deduction, which for 2014 was $3,950 and for 2015 is $4,000.  Non-taxable income, such as SSI or non-taxable Social Security or Railroad Retirement benefits, do not count toward the $3,950 or $4,000. 

In this situation the child does not have to live in your home as a member of your household, but you must provide more than 50% of his or her support.

Here are some examples, all assuming you provide more than half of the son or daughter’s support –

Your son, age 20, is a junior in college who lives away at school most of the year.  He has a summer job and earns $6,000 in W-2 wages.  You can claim him as your dependent.

Your 25 year-old daughter is in medical school.  She does not work and has no taxable income other than interest, dividends, and capital gains that total less than $1,000 for the year.  You can claim her as a dependent.

Here is a real-life example from my mentor’s practice.  Your 40+ year old son lives with you.  He does not work and has no income.  He basically lives off you.  You can claim him as a dependent.

How much tax will you save by claiming your child as a dependent?  Depending on your situation the savings can be substantial.

In addition to claiming an additional personal exemption – a $4,000 exemption will save $1,000 in federal tax for taxpayers in the 25% bracket – based on your level of income and the child’s age you may also be able to take advantage of the Child Tax Credit, Child and Dependent Care Credit or exclusion of child care benefits paid through a flexible spending account (FSA), and the Earned Income Tax Credit. 

The tax savings for having a dependent child, or the tax cost of losing a dependent, is much more substantial for a single parent with one child.

In order to be able to claim the tax-advantaged Head of Household filing status you must pay more than half of the cost of keeping up your home, which is the principal residence for more than 6 months of your qualifying child or qualifying relative.  A qualifying child does not have to be claimed as a dependent – a custodial parent can “release” the dependency exemption to the non-custodial parent – but a qualifying relative must be claimed a dependent.

So, as with just about every tax question, the answer to “can I claim my son, or daughter?” is “it depends”.

TTFN

A TIMELY PRE-SUMMER TIP

Now is a good time to refer you to a TWTP post from last year titled - GETTING READY FOR SUMMER – FILLING OUT FORM W-4 FOR A SUMMER JOB.

As you read the post substitute 2014 for 2013, and 2013 for 2014.  For 2014 the Standard Deduction for a dependent is the greater of $1,000 or the dependent's earned income plus $350, not to exceed $6,200 (plus $1,550 if blind).  And the maximum IRA contribution remains at $5,500.

A recent IRS Tax Tip release (“Information for Students Who Take a Summer Job”) provided a good reminder for dependents who will be working as waitpersons or bus persons –

“Keep in mind that all tip income is taxable. If you get tips, you must keep a daily log so you can report them. You must report $20 or more in cash tips in any one month to your employer. And you must report all of your yearly tips on your tax return.”

TTFN

GETTING READY FOR SUMMER – FILLING OUT FORM W-4 FOR A SUMMER JOB

Do you have a teen-age dependent that will soon be looking for a summer job?

Frequently, unless you prepare your child’s tax return yourself, the cost of preparing a short form for a dependent child with an a summer job, solely for the purpose of getting a refund of the federal and state income tax withheld, is more than the amount of the refund.

Before starting his/her job your son/daughter will be given a Form W-4 to fill out.  Line 7 of the W-4 allows an employee to claim exemption from federal and state income tax withholding, if he/she had no income tax liability for 2012 and does not anticipate earning enough to pay income tax for 2013, by writing the word “EXEMPT” in the box indicated.

Writing “EXEMPT” on the form means that the employer will withhold only FICA (Social Security and Medicare) and any required state unemployment and/or disability taxes from the student’s wages.

For 2013, the federal standard deduction for a dependent with a W-2 is the greater of $1,000 or the sum of $350 and the dependent's earned income, not to exceed $6,100 (plus $1,450 if age 65 or blind). The state amount varies, and may be more of less than $6,100.

If you do not anticipate that your son/daughter will earn more than $6,100 during 2013, including up to $350 in interest, dividends and capital gains, have him/her claim “EXEMPT” on his/her Form W-4. This way he/she will not have to file a federal or state income tax return simply to get a refund of the income tax withheld.

 

If your son/daughter has already filled out a Form W-4 for his summer employer, but has not begun work yet, have him/her fill out a new one claimint EXEMPT to give to the employer before starting work.

Of course, on the other hand, and if you will be preparing your son/daughters simple tax returns yourself, you can have him/her use unnecessary federal and state income tax withholding as a form of “forced savings”, so he/she does not urinate away all of his/her summer earnings.

And while we are talking about summer jobs, If your son or daughter has one you should consider opening up a Roth IRA account for him or her.

You can contribute 100% of your child’s earnings to the account, up to a maximum of $5,500.  If your son earns $2,400 this summer you can contribute $2,400 to a Roth IRA for him. If he earns $6,000 you can contribute $5,500.

There is nothing in the tax code that says that the money deposited in an IRA for your son or daughter has to come from the child’s funds.

There is no tax deduction for contributing to a Roth IRA, but most teenagers don’t need the deduction. Qualified distributions from a Roth will be exempt from federal, and probably state, income tax (assuming, of course, that the idiots in Congress don’t change the law in the future).

You can use a Roth IRA to encourage your children to work or to save.  If your son earns $5,000 in a part-time job, open a Roth IRA for him.  Or, if your daughter agrees to put $2,500 of her salary from a summer job in a Roth, match it and put in another $2,500.

If you put the maximum into a Roth each year for your 16-year-old from 2013 through 2018, when he/she will turn 21, and no other contributions are ever made, the account could grow to a truly tidy sum (in 6 figures) by the time the child turns 65.

A warning - there exists a potential problem with opening a Roth account for a child. Once the child reaches the “age of majority,” usually 18, he/she will have full access to all the funds and can “take the money and run.”

TTFN

OPEN A ROTH FOR YOUR KID

I recently posted a “summer” rerun on dependents and income tax withholding.  Here is some related advice -

If your son or daughter has a summer job you should consider opening up a Roth IRA account for him or her.

To qualify for an IRA your child must have “earned income” — wages or “net earnings from self-employment.” Money you give your child for doing chores around the house doesn’t count, but earnings from babysitting or mowing lawns may qualify.

You can contribute 100% of your child’s earnings to the account, up to a maximum of $5,000. If your son earns $2,400 for the summer you can contribute $2,400 to a Roth IRA for him. If he earns $6,500 you can contribute $5,000.

There is nothing in the tax code that says that the money deposited in an IRA for your son or daughter has to come from the child’s funds.

There is no tax deduction for contributing to a Roth IRA, but most teenagers don’t need the deduction. Qualified distributions from a Roth will be exempt from federal, and probably state, income tax (assuming the idiots in Congress don’t change the law in the future).

You can use a Roth IRA to encourage your children to work or to save. If your son earns $5,000 in a part-time job, open a Roth IRA for him.  Or, if your daughter agrees to put $2,500 of her salary from a summer job in a Roth, match it and put in another $2,500.

If you put the maximum into a Roth each year for your 16-year-old from 2012 through 2017, when he/she will turn 21, and no other contributions are ever made, the account could grow to a truly tidy sum (in 6 figures) by the time the child turns 65.

One caveat - there exists a potential problem with opening a Roth account for a child. Once the child reaches the “age of majority,” usually 18, he/she will have full access to all the funds and can “take the money and run.”

TTFN

SOME 1040 BASICS

Over the years I have been, on occasion, asked about “filing as married for half the year” or “claiming my son for half the year”.

Below is a review of basic tax law, a part of Taxes 101, which addresses these types of questions.

(1)  Your filing status for the year is determined by your marital status on the last day of the year.  If you are legally married on December 31^st you are considered for tax purposes to have been married for the entire year.  You must file your return for that year as either Married Filing Joint or Married Filing Separate (or possibly, in certain situations, Head of Household). 

Conversely, if you are not legally married on December 31^st, for example your divorce is final in December, you are considered for tax purposes to have not been married for the entire year.  You will file your return for that year as either Single or Head of Household.

(2)  If a person is alive for at least one day of the year he/she is considered for tax purposes to be alive for the entire year, and receives all the appropriate tax benefits, whether a dependent or an independent filer, for the entire year.

If your spouse goes on to his/her final audit at any time during the year, including January 1^st, you can file as Married Filing Joint for that year.

If a child is born at any time during the year, including December 31^st, you can claim that child as a dependent, with all the applicable tax benefits (Child Tax Credit, Earned Income Credit), for that year.

If, God forbid, a child is born on May 1^st and passes away on May 2^nd you can claim the child as a dependent for that year.

This suggests some very unique tax planning.

(1)  The marriage tax penalty is alive and well in our Tax Code.  In many cases a married couple will pay more federal, and perhaps state, income tax filing as married then if they could file two Single returns.  Filing separately could save some tax, but it is still generally not as beneficial as filing two Single returns.

It is “more better” in most cases to tie the knot early in the year instead of in the fall or winter.  As long as you are going to pay the price of being married for the entire year you might as well enjoy all the benefits (?) of marriage for as much of the year as you can.

And, if you are in the process of a divorce, it is “more better” in most cases to complete the process in November or December of 2012 instead of waiting till January or February of 2013.  This way you will be able to file as Single or Head of Household for 2012.

(2)  If your wife is pregnant and due soon – it would be to your benefit tax wise if the child was born before the ball dropped at Times Square and the new year was rung in.  If the child is born at 8PM on December 31, 2011, instead of 6AM on January 1, 2012, you get all of the associated tax benefits of a dependent child on your 2011 Form 1040. 

I am, however, not quite sure exactly what you can do to achieve this tax planning goal.  Some websites suggest eating spicy food, going for a walk or marching up stairs, or having sex to induce labor.   

TTFN

THE NEW TAX CODE - THE FINAL ITEMS

So what it left to re-write in the new simple, fair, and consistent Tax Code?

Contributions? I would not change the current rules for deducting contributions to church and charity – except to make the standard deduction for charitable miles equal to the standard deduction for all other miles (the amount currently used for medical and moving mileage) and have it indexed for inflation annually. This deduction would be determined annually by the IRS and not the idiots in Congress, who have not increased the amount in years.

Casualty and Theft Losses? I think I would limit this deduction, without any AGI exclusion, to “out of pocket” casualty losses from Presidentially-declared natural disaster areas and “theft” losses from Madoff-like Ponzi schemes.

Moving Expenses? I would keep the current rules, but make it an “employee business expense” deductible on Schedule A.

Medical Expenses? This is the only area where I have considered maintaining a % of AGI exclusion. I would want to limit the deduction to “excessive” medical expenses. As an alternative to the AGI-based exclusion I have thought about allowing a deduction for expenses in excess of a flat exclusion amount of $5000 for a single taxpayer or $10,000 for a married couple. What do you think about this?

I would once again make taxpayers age 65 or older eligible for an additional personal exemption, and not an additional standard deduction amount. And I would do away with the special tax treatment for legally blind taxpayers. I see no reason why blind taxpayers should be treated differently than any other disabled or handicapped taxpayer.

I have decided that I would not have a “dependent credit” - but instead double the personal exemption for dependent children under age 19.

Before I begin to put my proposals for the new Tax Code into summary format – is there anything I forgot?

TTFN

ASK THE TAX PRO - DEPENDENTS AND HEAD OF HOUSEHOLD

This question was originally submitted as an unrelated comment to an earlier TWTP post.

Q. If a man (age 24) lived with and provided over half the support for his girlfriend (age 22) and her child (age 2) all year, can he claim them as dependents and file as Head of Household? Between her short job and interest earnings, the girlfriend didn't make quite $3,400.

A. First question – can the taxpayer claim his girlfriend as a dependent?

To be claimed as a dependent one must be either a “qualifying child” or a “qualifying relative”.

The first test for a “qualifying child” is that “the child must be your son, daughter, stepchild, foster child, brother, sister, half brother, half sister, stepbrother, stepsister, or a descendant of any of them.” I assume that the “girlfriend” does not meet this test (are we talking about Arkansas?) – so she is not a “qualifying child”.

The tests for being a “qualifying relative” are –

1. The person cannot be your qualifying child or the qualifying child of any other taxpayer. We have shown that the girlfriend is not the taxpayer’s “qualifying child”, and let us assume she is not the “qualifying child” of anyone else (no info to the contrary provided) – so we assume she passes this test.

2. The person either (a) must be related to you or (b) must live with you all year as a member of your household (and your relationship must not violate local law). It is stated in the question that the girlfriend lived with the taxpayer, and we will assume that it was for the entire year – so she passes this test. If she moved in with the taxpayer in February she would not pass the test. The comment about “must not violate local law” has to do with common-law marriages – which I will say is not an issue in this situation.

3. The person's gross income for the year must be less than $3,400. The question indicates that her income was less than $3,400 - so she passes this test. The $3,400 mentioned here represents the amount of the personal exemption for 2007. For 2008 the amount to use is $3,500.

4. You must provide more than half of the person's total support for the year. According to the information provided the taxpayer did – so this test is also passed.

So the girlfriend is a “qualifying relative” – even though she is not related to the taxpayer.

There are now three (3) more tests to pass –

(1) Dependent Taxpayer Test - If you could be claimed as a dependent by another person, you cannot claim anyone else as a dependent. It appears that the taxpayer boyfriend is not being claimed as a dependent by anyone else, so this test is met.

(2) Joint Return Test - You generally cannot claim a married person as a dependent if he or she files a joint return. We should make sure the girlfriend is not married to someone else and filing a joint return with her spouse. Let us assume she is not (no info to the contrary) and say she passes this test.

(3) Citizen or Resident Test - You cannot claim a person as a dependent unless that person is a U.S. citizen, U.S. resident alien, U.S. national, or a resident of Canada or Mexico, for some part of the year. There is no indication in the facts given that the girlfriend is not a US citizen – so we will assume she meets this test.

So, the girlfriend meets the tests for being a “qualifying relative” and the tests for being a dependent. The taxpayer boyfriend can claim her as a dependent on his tax return.

Next question – can the taxpayer claim his girlfriend’s 2-year old child as a dependent?
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The question does not say that the taxpayer has legally adopted the child, so under the test we discussed above the child would not be his “qualified child”.

The first test for “qualifying relative” is that the person cannot be the “qualifying child” of another taxpayer. The child is the “qualifying child” of her mother. However this does not necessarily disqualify the child for the taxpayer boyfriend because according to IRS Publication 501 (Exemptions, Standard Deduction, and Filing Information) – “A child is not the qualifying child of any other taxpayer and so may qualify as your qualifying relative if the child's parent (or other person for whom the child is defined as a qualifying child) is not required to file an income tax return and either:

· Does not file an income tax return, or
· Files a return only to get a refund of income tax withheld.”

Based on her taxable income as presented, the mother does not have to file a federal income tax return, although she may file a return with no dependents and a “0” tax liability only to claim a refund of any income tax withheld on her small W-2 earnings.

However, if the mother filed a tax return to claim the Earned Income Credit based on her child, as could apply in this example, then the boyfriend could not claim the 2-year old as his dependent. If the boyfriend came to me to have his tax return prepared with the above information I would also want to see if the mother would be eligible for the Earned Income Credit (also available on the NJ state income tax return) and see how much of a credit she would receive.

It the EIC is not an issue then we can assume, based on the limited facts given, that the child would pass the other tests for being a qualifying relative and a dependent.

One must look carefully on the support test. If the mother is receiving child support payments from either the father or a government welfare program perhaps the boyfriend is not paying more than half the support for the 2-year old. We must also find out if the child’s father is claiming her as a dependent on his return using Form 8332. It is important to ask questions and get all the information before making a decision.

So we have determined that the taxpayer boyfriend can claim his live-in girlfriend as a dependent, and maybe the girlfriend’s 2-year old child as well.

Last question – can the taxpayer file as Head of Household?

According to Pub 501 – “You may be able to file as head of household if you meet all the following requirements.

1. You are unmarried or “considered unmarried” on the last day of the year.
2. You paid more than half the cost of keeping up a home for the year.
3. A “qualifying person” lived with you in the home for more than half the year (except for temporary absences, such as school).”

The taxpayer boyfriend, it appears, meets the first two requirements.

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A “qualifying person” is someone who “lived with you more than half the year, and he or she is related to you in one of the ways listed under Relatives who do not have to live with you on page 14, and you can claim an exemption for him or her.”

Page 14 of Pub 501 lists the “Relatives who do not have to live with you” as

· Your child, stepchild, foster child, or a descendant of any of them (for example, your grandchild). A legally adopted child is considered your child.
· Your brother, sister, half brother, half sister, stepbrother, or stepsister.
· Your father, mother, grandparent, or other direct ancestor, but not foster parent.
· Your stepfather or stepmother.
· A son or daughter of your brother or sister.
· A brother or sister of your father or mother.
· Your son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.

A person who is your “qualifying relative” only because he/she lived with you all year as a member of your household is not a “qualifying person” for purposes of meeting the Head of Household test.

Publication 501 specifically provides the following example (the highlight is mine)-

“Example 3—girlfriend.

Your girlfriend lived with you all year. Even though she may be your qualifying relative if the gross income and support tests… are met, she is not your qualifying person for head of household purposes.”

So the taxpayer boyfriend cannot file his tax return as Head of Household.

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Just a disclaimer - there was really not enough information provided in the question to answer the question with certainty. As I said above it is very, very important that all the "facts and circumstances" be given to your tax preparer so he/she can make an informed decision.

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Does anyone have anything to add?
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TTFN