Lake County Illinois Bar Assn. Seminar
Gary L. Schlesinger
1512 Artaius Parkway
Libertyville, IL 60048
Toll Free: 888-361-4745
This does not pretend to be an exhaustive discussion of taxation in relation to divorce but merely an introduction to some common situations encountered in almost every case. For more detailed information, do your own research or consult your own tax advisor.
There are a few ways that one may file income taxes: married filing jointly, married filing separately, single, head of household. One’s marital status on the last day of the calendar year determines one’s filing status.
In order to file jointly, the parties must be married on the last day of the year. Sec. 6013 of the Internal Revenue Code, hereafter, IRC.
Head of household status is available to unmarried people who maintain a home for a qualified dependent for whom the taxpayer may claim an exemption for at least half of the year. Sec. 2(b) IRC. The taxpayer need not claim the exemption on the tax return to file head of household. Sec. 173 Master Tax Guide. The advantage to filing this way is that the tax is less than that of a single person for the same income. It is greater than taxes on joint returns for the same income.
To file head of household, one must be unmarried. That means not married or married but separated for the last six months of the year.
If one is unmarried and not a head of household, one is single. Generally, single results in the highest tax for any given income.
If a case may be concluded in one calendar year or the next, prepare pro forma tax returns to see what filing status results in lower overall tax and end the case in the appropriate year.
Sec. 151 IRC
A tax exemption, not a deduction, is a tax savings as a result of being able to claim a person as an exemption on one’s tax return. For 2003, the exemption saves taxes on $3,050, on the federal return. This amount increases annually based on inflation. In 2002, the exemption saved taxes on $3,000. The exemption is reduced as income increases. In 2003, once adjusted gross income reaches $209,250 for joint filers, $174,400 for heads of household, $139,500 for single taxpayers, and $104,625 for married filing separately, the exemption is reduced as a tax savings. Sec. 133 Master Tax Guide.
The exemption results in tax savings on $2,000 worth of income on the Illinois tax return. So, that is a $60 savings.
The person entitled to the exemption for a child is the custodial parent. That is the person with whom the child lives for more than one half the year. However, the custodian may release the exemption to the non-custodian. To do this, the custodian must sign the form 8332 or similarly worded document. The non-custodian must attach that form or release to the tax return for the year in which the non custodian claims the exemption.
May the court order the non-custodian to release the exemption to the custodian?
Yes, it is not an abuse of discretion to do so IRMO Moore 307 Ill.App.3d 1041, 241 Ill. Dec. 465, 719 N.E.2d 326 (5th Dist. 1999)
Child Care Credit
A credit against tax due, but not to increase a refund, is allowed for a portion of child or dependent care expense incurred so the taxpayer may be employed. Sec. 21 IRC. The taxpayer claiming the credit must maintain a household for a dependent under age 13 for whom an exemption may be claimed.
The amount of the credit is 35% of employment related expenses. The maximum of child related expenses to which the credit applies is $3,000 for one child and $6,000 for two or more children. The credit is phased out when income exceeds $15,000. It is reduced by one percent for every $2,000 or fraction thereof that income exceeds $15,000. Once the credit is reduced to 20%, it stays at that regardless of income. Master Tax Guide Sec. 1301.
Taxpayers who have a child for whom they may claim a dependency exemption, may claim a tax credit of $600 for each qualifying child. The credit increases to $700 in 2005 through 2008; then to $800 for 2009 and then to $1000 for 2010. The credit is phased out as adjusted gross income exceeds $110,000 for joint filers, $75,000 for single and head of household filers and $55,000 for married filing separately filers. The phase out is $50 for each $1,000 or fraction thereof that the adjusted gross income exceeds the threshold. A portion of this credit may result in a refund. Sec, 24 IRC
College Education Tax Credits
There are two. The taxpayer must have the child as an exemption. The Hope Scholarship Credit is a maximum of $1,500 per year for the first two years of post high school education. The second is the lifetime earning credit, which is available for any year in which the Hope credit is not claimed.
The Hope credit is 100% of the first $1,000 of tuition paid and 50% of the next $1,000 of tuition paid. It does not apply to non-tuition items such as room and board, books, medical expenses, or, transportation. It is not available to be used if there are no such expenses. So, if there are scholarships and grants that pay the tuition, then the credit cannot be taken against the tuition paid by the scholarships and grants. The credit is available for tuition payments to a school eligible to participate in the Department of Education student aid program. A student is eligible if he or she has not completed 2 years of school, is at least a half time student and has not been convicted of a felony drug offense for possession or distribution.
There are income limitations. For single taxpayers, the phase out begins at adjusted gross income of $41,000 and is gone at $51,000. For joint filers, $83,000 and $103,000.
The result of this is that if the client or an ex spouse has income below the threshold, the tax exemption for the first year of college is worth the $1,500 credit, plus the $60 Illinois taxes saved, plus the marginal tax rate times $3,050. If the marginal rate is 25%, the exemption is worth $3,050 times .25, or $762.50 plus $60 plus $1,500 or a total of $2322.50. So have the parent with the smaller income claim the exemption for the first two years of college. Have that parent pay the first $2,322.50 of college expense and then divide the balance of the college expense pursuant to 750 ILCS 5/513. Do not ignore or forget about the exemption when dealing with the college issue!
The lifetime credit is available for a student taking one or more courses at an educational institution and for whom the Hope credit is not taken that tax year.
Be careful when giving advice about this. This credit needs to be coordinated with the withdrawals from educational savings accounts. It is enough for divorce practitioners to know to ask the questions about this credit and then either do the research to give the advice or refer the client to a tax advisor with more knowledge. Sec. 25A IRC and Master Tax Guide sec. 1303.
Earned Income Credit
There is a refundable credit, meaning that this may not only result in no tax being paid, but also the client getting money back, for low income clients with earned income below a certain threshold. Low income means the credit begins to phase out at adjusted gross income of $13,730 for one or two children and a single filing status. The credit is completely phased out at adjusted gross income off $29,201. One need not have a child as an exemption, but, the child must qualify. That means the child must be under age 19, or 24 if a full time student; be the taxpayer’s child; share the same principal place of abode in the U.S. with the taxpayer for more than one half the year. The taxpayer must list the name, age, and identification number of the child on the taxpayer’s return. Sec. 32 and Master Tax Guide Sec. 1375.
Now, if the child lives more than half the year with the taxpayer, the child is eligible to be an exemption of the taxpayer. However, if the taxpayer releases the exemption on form 8332, it appears that the taxpayer may still get the earned income credit for that qualifying child.
An employed person fills out this form for the employer, telling the employer how many exemptions to take for the tax year. Each exemption taken decreases the tax withheld and increases the net income. If you have a client with a large tax refund, he or she has too few exemptions on the W-4 form and is loaning money to the government interest free. As taxpayers, we say, “thank you.” As attorneys, we should tell the client to prepare a new W-4 form with the correct number of exemptions.
Exemptions are not just people. One may claim one exemption for each $3,050 of itemized deductions or for each $3,050 of maintenance paid. Prepare a pro forma tax return for your client for the year to see what the tax will be at the end of the year compared to the current withholding. Then, try to convince the client to adjust the withholding to the correct amount of tax due. Good luck. This is the way to show the proposed maintenance payer that current net income is irrelevant to how much money he or she will have left after paying the tax and the maintenance.
Some attorneys have the child support payer decrease the number of exemptions, to increase the tax withheld to show a smaller net income on the pay stub to pay less child support. Nice try. 750 ILCS 505 sets child support on net income with state and federal taxes properly calculated for withholding or quarterly payments. (a)(3)(b). The Second Appellate District has held that tax refunds are income for determining child support. IRMO Pylawka, 277 Ill.App.3d 728, 214 Ill.Dec. 651, 661 N.E.2d 505 (1996).
www.irs.gov is the IRS web site. It has lots of helpful information and all the forms you need in .pdf format to download.
The Illinois Practice of Family Law by Muller Davis. West Publishing Co. This is the book you should all have and use as your first reference tool. The judges have it on the bench, why would you not have it in your office?
The U.S. Master Tax Guide. CCH Publishing Co, This is also on the bench in the courtrooms. It is updated annually. Last year’s does you no good. Always have the current one.
A great accountant whom you may call with questions that the above resources cannot answer.