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Enhanced Tax Credits Become ‘Bargaining Points' in Divorce Cases

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  • The $1.9 trillion American Rescue Plan boosted the child tax credit, earned income tax credit and child and dependent tax credit for 2021.
  • These enhanced write-offs may be worth thousands of dollars and are becoming bargaining chips in divorce cases.
  • Financial experts cover what ex-spouses need to know about these tax breaks.

Divorcing parents often have plenty to navigate.

And the latest stimulus package has dumped even more onto the negotiating table in the form of enhanced tax credits.

The $1.9 trillion American Rescue Plan provided Covid-19 relief for millions of Americans, including increases to three write-offs in 2021: the child tax credit, the earned income tax credit and the child and dependent care tax credit.

These enhanced tax breaks may be worth thousands of dollars for eligible families and are adding complexity to divorce cases, financial experts say.

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"These credits are now becoming the bargaining points that spousal support used to be," said Sallie Mullins Thompson, certified financial planner and certified public accountant at the firm with her name in New York.

Ex-spouses may deduct alimony payments for divorces finalized before 2019. However, the Tax Cut and Jobs Act of 2017 cut that perk for new divorcees, reducing opportunities for tax savings, she said.

While the earned income tax credit and child and dependent tax credit require wages or payments from a job, the child tax credit doesn't have the same requirement, said Davon Barrett, CFP and lead advisor at Francis Financial in New York.

"It's a good amount of money, regardless of employment status," he explained.

This flexibility has made the child tax credit — worth up to $3,600 for children under age 6 and $3,000 for kids between ages 6 and 17 — more important for divorcing parents to discuss, Barrett said. 

To qualify for the child tax credit, a parent must cover at least 50% of their kid's expenses, and they must live with them for at least half of the year.

However, ex-spouses may allow the other parent to claim the write-off by filling out Form 8332 and attaching it to their 2021 return.

In some cases, it may make sense for the higher-earning spouse to collect the child tax credit, assuming they don't exceed the income phase-outs, said Mullins Thompson. 

A parent filing as head of household starts to phase out for the enhanced amount with modified adjusted gross income over $112,500, and a single filer won't receive the full amount once they earn more than $75,000.

Moreover, the advanced payments may cause trouble for some divorcing parents since the IRS uses 2020 income for eligibility. 

"Unless you're in a cash bind, I wouldn't recommend taking it up front," Barrett said. 

However, those who have already received payments may still opt-out of future payments or set aside money for potential liability at tax time, he said.  

Working with a tax professional may be the best way to avoid trouble, particularly someone who is already familiar with each spouse's finances, Barrett said.

Future legislation

While President Joe Biden proposed making the enhanced tax credits permanent in the American Families Plan, it's unclear whether Congress will extend these benefits past 2021.

Still, those finalizing a divorce need to be proactive. Divorcees may discuss possible extensions and address who may claim which credits with language in their agreement, Mullins Thompson said.

However, regardless of what happens in Congress, experts agree it's better for divorcees to discuss the consequences early.

"The sooner you put it on the table, the sooner you can come up with solutions," Barrett adds. 

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