Using the head of household status comes with some benefits that need to be taken into account in a divorce process.
To obtain a head of household status the taxpayer has to:
- Be unmarried at the end of the tax year
- Provide for more than 50% of the household expenses from the taxpayer’s income, savings or personal capital
- Have a qualifying child or dependent
To be considered to have a qualifying child the taxpayer must verify the following:
- the child must be the taxpayer’s biological child, stepchild, foster child, sibling, step sibling, half sibling, or a descendant (child, grandchild, great grandchild, etc.) of one of these relatives
- The child must have lived within the taxpayer’s home for more than six months during the tax year
- The child needs to be younger than the taxpayer
- As of the end of the tax year, the child must be under 19 if not a student, or under 24 if is a full-time college student
- The child must not have paid for more than half of her living expenses during the tax year
Issues to consider
- The phrase biological child
In today’s day and age many parents who have children receive medical assistance. As a result the child may not be considered a biological child of the taxpayer. If there was a donor involved or the child was adopted the child may not be considered biological. This could disqualify the taxpayer from using the head of household status.
In context to a divorce this can become a very sensitive issue. The parent who may not be considered the biological parent will already perceive the situation as giving something up in the divorce settlement. Therefore these issues must be handled with sensitivity and care to manage the outcomes of the divorce and allow the parents to continue to function as a functional family.
- Difference in tax liability may be a “shared liability” due to the HoH vs. single status
The tax bracket for head of household is more favorable than a tax bracket offered as a taxpayer who files as Single or Married Filing Single. In context to a divorce, if the agreement provides one parent child custody or significant parenting rights where the rules outlined above are met then that parent may be able to file head of household.
The difference in tax liability between a Head of Household tax filing status and Single tax filing status can be material, depending on the income involved. Therefore, this difference may be considered a shared liability that has to be reflected on the marital estate and properly allocated between the divorcing parties.
- There is value in the itemized deduction limitation for different filing statuses
The 2018 tax reform act established an itemized deduction limitation for Head of Household limitation equal to $18,000. Taxpayers who have a tax filings status as married filing jointly enjoy a $24,000 itemized deduction limitation. Single filers will experience a $12,000 limitation.
In context to a divorce, a divorcing party who is awarded the Head of Household status will enjoy a higher itemized deduction limitation than the party who files as Single. The difference is $6,000 ($18,000 less $12,000). If the parties were in the exact same tax bracket (assume 30%) the $1,800 ($6,000 x 30%) would be considered an asset on the marital estate that should be shared appropriately between the parties for an agreed upon period of time. This asset becomes exacerbated if the child or children are young and all of the rules stay true until the child becomes 19 years old if the child is not a student and 24 if the child is a student.
For example, if a couple seeks a divorce and have two biological children. One child is 10 years old and the other is 4 years old. The parent who is awarded the Head of Household Status may enjoy that status until the child reaches the prescribed age as defined above (19 or 24 years old).
Here is an example:
Head of household itemized deduction limitation $18,000
Single itemized deduction limitation $12,000
# of years until child reaches age (4 to 24 years old) x 20 — assume 24 years of age
Asset that needs to be taken into account $120,000
Effective tax rate 30%
Financial benefit $36,000 *— asset on marital estate
* There likely would be a net present value assigned to the asset as a result of the tax benefit would be experienced over time not realized 100% as of the settlement date.
It is worthy to note a similar calculation would hold true for the favored tax bracket noted above.
About the Author
Larry Smith is a Founding Partner of Divorce Outcomes, a specialized professional services firm that manages all of the financial aspects in a divorce process. Since 2003 he has worked as a trusted financial advisor, financial advocate, divorce architect and technical financial expert; he is not an attorney. He is an alumni of KPMG and Andersen with expertise in technical accounting, forensics, sophisticated taxation, management consulting, risk management, advanced process engineering, business combinations, divorce management, multi-party negotiations, advanced quality analytics and cognitive performance technologies. Since 1986 Larry has been advising individuals and organizations about innovative financial solutions to resolve complex financial challenges that arise in life and in business.
For both personal and business divorces, Larry is considered an expert in divorce strategies, divorce process management, financial divorce architecture, financial risk management, taxation for divorces, financial divorce forensics, advanced divorce analytics, financial divorce negotiations and mediation, business valuations and sophisticated equity structures. He helps clients shape complex financial decisions, manage communication risks and ever-changing negotiating positions to strategically preserve or grow wealth from these types of transactions.
If You Have a Question
If you have a question, feel free to contact me at [email protected] or 617-680-5222. The call is free. I will spend 30–60 minutes with you. I will provide you an honest assessment as to where I think you are positioned in your divorce process or answer any questions you have. I may provide you some guidance, insight or advice that you can take with you as you wish. There is no obligation to move forward. The phone call is designed to ease your fears, provide you some options to pursue and a potential road to run on that can lead you down a path to achieve a successful outcome.
About Divorce Outcomes
Divorce Outcomes is a specialty services firm that helps people both domestically and internationally manage all of the financial decisions that arise in their divorce process. We are not attorneys. We are financial experts who partner with our clients as their personal financial advocates. We help our clients manage their divorce process, uncover hidden financial risks, architect divorce solutions, manage ever-changing negotiating positions, communicate complex financial matters and close the divorce process as soon as possible with a goal to arrive at the best outcomes possible. Throughout the process we evaluate the current state of our clients’ financial lives with an objective to best reposition their future. We do not sell any products. We simply raise issues that are in our clients best interest. Our clients share with us we:
- unfold, analyze and repackage their financial life so they are well positioned after their divorce
- preserve the value of their business or marital estate
- continuously strive to provide a return on our services
- build balanced financial solutions grounded in evidence
- find ways to make our client, and at times both parties, money through the process
- design their divorce to work for them and their family’s life
- provide mental clarity to make decisions
- reduce the total process time from start to close
- minimize the stress and unpleasant memories that can last a lifetime
As we reach an agreed upon settlement structure, we help our clients identify a fitting attorney who can leverage the financial solution to draft and record the requisite legal documents. Where outcomes are at risk from a traditional process, we function as expert financial negotiators or financial mediators to turn around the situation and achieve our client’s desired outcomes.
This communication is for general informational purposes only which may or may not reflect the most current developments. It is not intended to constitute formal advice or a recommended course of action as every person’s situation is unique and different. The information here is not intended to be, and should not be, relied upon by the recipient to make a decision without professional guidance.