Income Tax Planning for Life Transitions: One Size Does Not Fit All

Although he is not credited with originating the phrase, Benjamin Franklin included the famous quote, “...in this world nothing can be said to be certain, except for death and taxes,” in a letter to a French colleague in 1789.¹

One might argue that Mr. Franklin’s list of two certainties is not all-inclusive and that other things, like change, could also be considered certain. Hardly a day goes by without experiencing some form of change in our lives. There are countless examples of change in our lives, but when we think about change, do we immediately think of income taxes? Probably not. Yet, we hear about changes in exemptions, marginal tax rates, and exclusions every time a new administration takes over. But these changes typically relate to how much income tax each of us will pay in our particular situations. We do not think of changes in income taxes as a constant presence in our lives, ebbing and flowing as we go through our days.   However, if we reflect on our lives as we near the end, we would see how our tax situations have changed over the years. Are these changes worth considering and planning for? Absolutely. Here are some examples to illustrate the point:

Death of a Spouse

Spouses typically file under the “Married Filing Joint” (MFJ) status, which offers lower overall tax rates compared to the “Single” (S) status. In the year of death, the surviving spouse can still file MFJ, but in all subsequent years, they must file as “Single” unless remarried. Since household income often does not decrease significantly for retirees after one spouse dies, the surviving spouse may face a higher effective tax rate, particularly for those on fixed incomes.

Divorce

Divorce also changes filing status for both parties, effective the year the divorce is final. This leaves little time for planning unless the settlement spans several years. After filing as MFJ during the marriage, divorced spouses will file either as “Single” (S) or “Head of Household” (HOH), depending on who has custody of any minor children. HOH status is advantageous for the custodial parent, while the other must file as “Single” unless remarried. Divorce settlements also require decisions about which party claims exemptions for minor children, the child tax credit, and deductions for property taxes and mortgage interest on the family home.

Marriage

Single individuals who marry can choose between two filing options: “Married Filing Joint” (MFJ), or “Married Filing Separate” (MFS), which is similar to both parties filing “Single” (S). Depending on each party’s income and deductions, one filing status may be more beneficial than the other after comparing the total taxes the couple would owe under each scenario.

Birth of a Child

That little bundle of joy can bring tax benefits, such as a Personal Exemption deduction (suspended through 2025), and the advantage of having investment income taxed at a lower rate or being tax-free in 529 college savings plans when used for qualified college expenses. Some states also allow deductions for contributions made to 529 plans.

Relocation to a New State

If you are moving from a state with no income tax to one that has an income tax, you may be in for an unpleasant surprise. Conversely, if you are moving from a state with income taxes to one without, you could be in for a pleasant surprise. One potential surprise is that if you do not move on exactly December 31^st or January 1^st, you may have to file two “part-year" state income tax returns, depending on how much time you spent in each state during the year of your move. This may also require more detailed tax estimates and possibly some estimated tax payments compared to prior years. Additionally, your move may impact deductions for your 529 college savings plans.

Other Age-Based Changes and Income Taxes:

• Minor child turns 21.
• 529 plan beneficiary graduates or leaves college.
• Qualified retirement plan participant with employer securities turns 55.
• Penalty-free withdrawals from IRAs and qualified plans begins at age 59 ½.
• Social Security benefit election opens at age 60 for widows/widowers and at age 62 for retirement benefits.
• Eligibility for Medicare begins at age 65.
• Required Minimum Distributions (RMDs) from IRAs and qualified plans begin at age 73 or 75, depending on year of birth.

Whew, that’s a lot! Fortunately, you have a seasoned team of Apella Wealth financial advisors who are experts in taxes and how life transitions impact them. If you anticipate any of the life changes mentioned above, or others, do not hesitate to reach out to your trusted advisor.

To close, we leave you with another quote, this time from the brilliant Albert Einstein: “The hardest thing to understand in the world is the income tax.”²

Sources:

1. Sparks, Jared (1856). The Writings of Benjamin Franklin, Vol. X (1789-1790). Macmillan. P.410.
2. Albert Einstein (2010). “The Ultimate Quotable Einstein”, p.479, Princeton University Press

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