Tracking Tax Events: Which Life Changes Affect Your Taxes?

by Silicon Valley Blogger on 2011-10-163

Which tax events trigger adjustments to your tax situation?

A lot of decisions we make in our daily lives have an impact on our taxes. Some of these changes yield beneficial credits, while others increase the amount we need to pay to the IRS. It’s probably good to know what kind of events may trigger a tax adjustment so that nothing strikes us as too unexpected when tax time rolls around. Let’s look at some typical life events to see how they influence our tax situation.

Tax Events When Raising A Family

This first category accounts for a majority of our tax adjustments as adults settle down and expand their families. Gaining a spouse, purchasing a home and the addition of children to the family generally provide perks like credits and deductions.

1. Getting married. When you’re planning your wedding, picking out the flower arrangements and finding the right photographer are a lot more compelling than your tax status. However, you’ll need to contact the Social Security Administration if you change your name. The correct form of your name is vital when you file your taxes. Also, check with your Human Resources department at work to see about filing a new W-4 form. Updating your W-4 lets your employer withhold the right amount of taxes, which I think you’ll appreciate in April.

When you’re ready to file your taxes, you and your spouse can file separately or jointly. For the most part, it’s to your benefit to file jointly because you’ll be able to access a lower tax rate. Also, tax credits like the Earned Income Credit aren’t available if you’re filing separately.

2. Buying a home. Some homeowners put a lot of stock on the mortgage tax deduction they expect to receive. If you’re carrying a mortgage, you’ll be able to start deducting the mortgage interest you pay. The points you pay during closing, property taxes and your private mortgage insurance (PMI) can qualify you for deductions, too. Over the years, be sure to keep track of your home improvements to adjust the value of your home if you decide to sell it. Also, look out for tax credits for energy efficiency when making home improvements. The Department of Energy’s Energy Savers has a roundup.

3. Adding children to the family. The birth and adoption of children practically rain down tax credits and deductions on families. Start off by signing up each child for a Social Security Number, then update your W-4 form to claim them as dependents. If you’re a single parent, explore the option of filing as a head of household because you’ll pay less tax compared to filing under the single status.

When you file your taxes, the children count as dependents, and you’re able to claim the Child Tax Credit that’s worth $1,000 for each child under age 17. Depending on your income, you can qualify for the Earned Income Credit, too. The EIC can be worth thousands. If you work and pay for child care, be sure to look into the Child Care Credit as well.

Later on, when your kids are on their way to college, you still might be able to claim them as dependents unless they’re filing their own tax returns. Also, some education credits may apply. See if the Student Loan Interest Deduction applies to you. It might allow you to deduct up to $2,500.

4. Getting divorced. If you divorce, your tax status changes again. If you’re a parent with custody of your children, you’ll find it more advantageous to file as a head of household instead of selecting single as your status. If you’re paying alimony, that’s another deduction. But the reverse works too: you’ll pay income tax on alimony if you’re receiving it. Take note that child support isn’t taxable income.

Taxing Work: Your Job, Business & Retirement

Of course, our work lives also factor into tax adjustments. Starting your career or business, and planning your retirement can impart important benefits. However, you need to watch out for taxes if you want to use your retirement funds before you’re of age.

1. Starting a new job. Usually when you begin working at a new place, you’ll be given a stack of forms to fill out. Unless you’re classified as a contract worker, one of these forms is the W-4 I mentioned earlier. Be sure to go over this form carefully, because you don’t want to end up having to pay an additional amount for taxes when you file your return. If you wound up moving to start this job, you may be able to claim some of those expenses, as well as some job-hunting expenses. Making more or less income can influence your tax obligation in a huge way: I’ve known families that have opted to stay as single income households due to tax reasons.

2. Starting a retirement account. A 401(k) or other types of retirement accounts are my favorite job benefits, because they often imply “free money” (e.g. there’s employer matching). With a 401(k), you don’t pay taxes on your earnings until you withdraw them. Of course, Individual Retirement Accounts also provide tax benefits. But watch out! If you need to tap your money too early, you might end up paying taxes and penalties.

3. Starting a business. The self-employed will need to pay their own taxes. Above a certain amount, you’ll be expected to pay estimated taxes quarterly. Meanwhile, starting a business can yield deductions for your business expenses. Some of these expenses include travel, advertising and vehicles. You’ll want to prepare Form 1099-MISC for your contractors and W-2 forms for your employees. The Small Business Administration has a checklist for starting your own business.

4. Bankruptcy. When you declare bankruptcy, you’re creating what’s called a bankruptcy estate. This estate needs its own Tax Identification Number and a trustee needs to file and pay its taxes. You might be excluded from taking some deductions. Since bankruptcy can become complicated quickly, seek help if you’re unsure of the tax issues. Learn more about bankruptcy rules from Smart Money.

Death, Taxes & Tough Life Adjustments: Additional Life Changes

Some tax adjustments are the result of events we can’t anticipate when we’re younger.

1. Your parents become your dependents. If you’re providing the majority of support for your elderly parents and they can’t be claimed as anyone else’s dependents, you should be able to claim them. However, you yourself can’t be claimed as a dependent or they won’t qualify. The AARP has some information about claiming parents as dependents.

2. Credits for the elderly and disabled. You might be able to claim the Child and Dependent Care Tax Credit if your spouse or a dependent is disabled. There’s also a Credit for the Elderly or Disabled. You can qualify for it if you’re over 65 or disabled.

3. Death. After death, one’s estate might be liable for taxes or might earn a refund, depending on the circumstances. If you’re a qualifying widow or widower, you may be eligible to file taxes using the married-filing-jointly tax rate. Learn more about estate taxes from the IRS.

What Are Other Taxable Events & Triggers?

As you can see, it seems that almost every life change you go through can affect your tax status. Stay aware of these tax adjustments as you move through life with the help of a financial planner or tax preparation software such as TurboTax.

There are a whole lot of other events that can trigger tax changes — in fact, I sometimes feel that doing ANYTHING can trigger a tax event. To get a picture, just take a look at this list of tax deductions from the IRS. This list just scratches the surface. If you fall ill, own investments, donate to charity, gamble or even end up becoming an accident or crime victim, you can end up with a tax trigger.

Use A Tax Organizer!

Given all these things to keep track of, I’d suggest using a “Tax Organizer” of sorts to keep things in order. I like the fact that my enrolled agent sends me one each year, prior to our annual appointment.

Sample questions in a Tax Organizer include: Did you get a divorce last year? Were there any new additions to your family? Did you buy an investment property? And so on and so forth.

This tax organizer allows us to enter our financial data in convenient sections. I appreciate the fact that my tax guy lives in the 21st century since we use a secure online application to do the entries. If I fill up the organizer with little hassle and make his job easy, then I get a discount for his services. In general, this is supposed to save us time when we have our face-to-face annual tax preparation and consultation meeting, during which we then simply spend the time to get our tax data blessed or find out if we need additional adjustments, have points of contention or have missing information that needs follow up.

Along with the folders of receipts, statements, documents and forms, the completed tax organizer has come in handy, particularly when unusual life changes in the past prompted these additional tax events for our household:

(1) My spouse quit his job, causing us to sell all his stock options in a very short span of time.
(2) We started a few home businesses and a consulting service.
(3) We did some minor stock trades that incurred both a profit and a loss (well ain’t that a wash?).

Just looking at these events alerted me to the strong possibility of having to pay more taxes for that given year. And as it turned out, taxable event #1 actually had a huge impact. Take a mental note of those things that have happened to you and your family during the year, so there are no surprises come tax time.

Created February 21, 2007. Updated October 16, 2011. Copyright © 2011 The Digerati Life. All Rights Reserved.

{ 3 comments… read them below or add one }

Kristin April 23, 2008 at 1:25 pm

I know what you mean about taxes. I never even considered an enrollment agent. I need to badly. Thanks for your advice on this.

Yazmin October 20, 2011 at 10:43 am

Your write-up is so comprehensive. I’m self-employed, but most of this information is still relevant. I’m going to look into the tax organizer you refer to — I mean, who doesn’t want a discount?

Silicon Valley Blogger October 20, 2011 at 12:56 pm

Ah, the Tax Organizer idea came from my Enrolled Agent. He offers one as part of his service. So it’s a pretty nifty document (both paper and electronic form) which he provides his clients to help organize their tax material before he delves into the details. I’ve found it to be pretty helpful in getting me to begin preparing for tax season. The way I function during tax season, I need one of these things given the amount of inertia I wade through to start getting ready!

If you have a tax professional you use, you may want to find out if they offer this type of thing or whether they suggest some similar tools. Tax software already does a lot of the work for DIY types, I believe.

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