Tax Planning for Life Changes

The tax return you filed last year was built for the life you had last year. Marry, divorce, have a child, buy or sell a home, lose a job or inherit money, and the rules that apply to you change, often on a date you did not choose, and often with a deadline that passes before anyone mentions it. This chapter goes through the life events that move a tax bill the most, what changes with each, and the decision that has to be made before the year ends.

Marriage: the penalty, the bonus and the date that decides

Your filing status for the whole year is set by whether you are married on December 31. Marry on New Year's Eve and you file as a married couple for that entire year.

Couples can file jointly or separately. Joint filing is usually cheaper, and the old idea that marriage always raises tax is mostly out of date: for 2026 the joint brackets are exactly twice the single brackets up to the 32% band, and the joint standard deduction is twice the single one.

Two partners each earning $85,000 would each owe $9,870 filing single. Filing jointly on $170,000, they owe $19,740, exactly twice that: no penalty and no bonus.

When incomes are unequal, marriage usually lowers the tax.

A single filer earning $150,000 owes $24,734 at a top bracket of 24.0%. Married to someone with no income, the same earnings on a joint return owe $15,340, at a top bracket of 22.0%. Penalties still appear for two high earners, because the top brackets are less than double, and in a few places that matter to specific couples: the cap on state and local tax deductions, $40,400, is the same for a married couple as for a single filer; the net investment income tax starts at $250,000 for a couple against $200,000 for each single filer; and some credits phase out at joint incomes less than twice the single level. Filing separately rarely helps and costs several credits, but it can matter for a spouse on an income-driven student loan plan.

After the wedding, each spouse should file a new Form W-4 with their employer: two paychecks each withheld as if single can leave a couple under-withheld once their incomes are combined. If either spouse changed name, update it with Social Security before filing, so the names on the return match.

Divorce: what is and is not taxed

Alimony. For divorce or separation agreements signed after 2018, alimony is not deductible by the payer and not income to the recipient. Older agreements keep the old treatment unless changed to adopt the new rule.

Child support is never deductible or taxable.

Dividing property. Transfers between spouses as part of a divorce are not taxed, but the cost basis travels with the asset. A brokerage account worth a given amount with a large unrealised gain is worth less after tax than the same amount in cash, and a traditional 401(k) is worth less than a Roth of the same balance. Compare assets on an after-tax basis before agreeing to an "equal" split.

Retirement accounts. A 401(k) or pension is divided under a qualified domestic relations order, and a payment from the plan to a former spouse under that order avoids the 10% early-withdrawal penalty. An IRA is divided by a transfer under the divorce decree. Moving money any other way can make the whole amount taxable to the owner.

Filing status and children. You are unmarried for the whole year if the divorce is final by December 31. A parent with whom the child lived for more than half the year can usually file as head of household, which has wider brackets than single. The custodial parent may let the other parent claim the child tax credit by signing Form 8332.

A new child

A child brings a child tax credit for each qualifying child under 17, which needs a Social Security number for the child issued by the return's due date, so apply for the number at the hospital. The credit amount and its income phase-out are set by law and indexed; the IRS publishes the current figures on its child tax credit page. Other breaks to check: the child and dependent care credit, a dependent care flexible spending account through an employer (a birth is a qualifying life event, so most plans let you enroll within about 30 days without waiting for open enrollment), and adding the child to your health plan within the plan's window. A 529 education savings plan does not reduce federal tax, but growth is tax-free for qualified education costs and many states give a deduction for contributions.

Buying or selling a home

Buying a home helps only if you itemize, since mortgage interest and property taxes are itemized deductions; with a standard deduction of $32,200 for a married couple, many new owners still take the standard amount. Selling a main home is far more favourable: if you owned and lived in it for at least two of the five years before the sale, up to $250,000 of gain ($500,000 for a married couple filing jointly) is excluded from income. Keep records of improvements, since they add to your cost basis.

Job loss, a low-income year, an inheritance

A year with less income is a tax opportunity, not only a setback. Long-term gains may fall into the 0% band, and converting part of a traditional IRA to a Roth costs less in a low bracket (chapter 2). Unemployment benefits are taxable federally, so consider having tax withheld from them.

Inherited investments usually get a stepped-up cost basis equal to their value on the date of death, so the heir can sell soon after with little or no gain. Inherited retirement accounts are different: most non-spouse beneficiaries must empty an inherited IRA within ten years of the owner's death, and if the owner had already started required distributions, must also take a distribution in each of those years. Spreading withdrawals over the ten years usually costs less tax than taking it all at the end. A surviving spouse can file jointly for the year of the death and, with a dependent child, use joint rates for two more years.