Tip of the Month:
Federal Tax Rates for 2004

The IRS has released the tax rates for 2004 reflecting the annual inflation adjustments (Revenue Procedure 2003-85 contained in Internal Revenue Bulletin 2003-49 dated December 8, 2003). These are the actual tax rates which will be used when 2004 tax returns are filed early in 2005. These are NOT Circular E tax rates which are used by employers to withhold taxes from paychecks. Circular E tax rates are not appropriate for divorce analysis and the following rates should be used in evaluating divorce settlements in 2004.

 

Single Taxable Income	Rate	Head Household Taxable Income	Rate
0-7,150	10%	0-10,200	10%
7,150-29,050	$715 + 15% over 7,150	10,200-38,900	$1,020+ 15% over 10,200
29,050-70,350	$4,000 + 25% over 29,050	38,900-100,500	$5,325 + 25% over 38,900
70,350-146,750	$14,325 + 28% over 70,350	100,500-162,700	$20,725 + 28% over 100,500
146,750-319,100	$35,717 + 33% over 146,750	162,700-319,100	$38,141 + 33% over 162,700
Over 319,100	$92,592.50 + 35% over 319,100	Over 319,100	$89,753 + 35% over 319,100

   

The maximum Social Security tax for employees will be $5,450 (6.2%) while the tax for self-employed workers will be $10,900 (12.4%). In addition, the Medicare Tax of 1.45% for employees and 2.9% for self-employed workers is applied to all earned income.

Other Important Tax Change from 2003 Relating to Divorce

Increase in Child Care Credit

The income ranges for the child care credit were changed in 2003 and the child care credit was increased. The 20% maximum rate applies if income is greater than $43,000 and a 35% rate applies to the first $15,000 of income.

Child Care Credit Income Ranges and Credit Percentages      2003 and thereafter

0-15,000	35%
15,000-17,000	34
17,000-19,000	33
19,000-21,000	32
21,000-23,000	31
23,000-25,000	30
25,000-27,000	29
27,000-29,000	28
29,000-31,000	27
31,000-33,000	26
33,000-35,000	25
35,000-37,000	24
37,000-39,000	23
39,000-41,000	22
41,000-43,000	21
Over 43,000	20

The maximum credit at low income levels was changed in 2003 as shown below:  

The child care credit can be important in divorce analysis because some states integrate a recovery of child care costs into the child support formula and offset such costs with the child care credit. Since child care credits were increased in 2003, guideline child support has been impacted if your state is using the child care credit to reduce child care costs considered to be shared in the child support calculation.

Tax Act of 2003

There are two significant aspects of Tax Act of 2003 which will continue to be very important in divorce in 2004 and are repeated here for anyone who is not familiar with the tax reduction legislation of 2003.

Elimination of “Marriage Tax Penalty” When Total Income is Under $66,000

If you look at the tax tables show above, you can see that that 10% and 15% tax brackets for Single are exactly ½ of the Married-Joint tax brackets. In addition, the 10% and 15% tax brackets are the same for Single and for Married-Separate up to $58,000 of taxable income (equal to gross income of $66,000).

This elimination of the “Marriage Tax Penalty” for middle and lower income individuals is very important in divorce. Because federal taxes are going to be the same if these individuals file as Single, Married-Joint or Married-Separate, taxes are no longer going to be a significant consideration in determining if the divorce should take place in 2004 or early in 2005. In addition, since the tax for a Single and a Married-Separate return will be the same if gross income of each individual is under $66,000, divorcing couples can file separate returns more frequently and not be forced to file a Married-Joint return just to save taxes.

From a tax perspective, the timing of divorce is now more neutral than in the past.

This is important in divorce because separate pre-divorce tax returns eliminate potential problems of a fraudulent joint return. Separate returns eliminate the need to later use the “Innocent Spouse” rules if there is a fraudulent joint return. A more complete discussion of this matter is available in the September, 2003, Divorce Tax Tips Newsletter.

Alternative Minimum Tax (AMT) and Divorce

We normally think of the AMT as applying to very high income individuals who have a lot of special “tax preference items”. This generalization is not accurate – the AMT is a second tax formula which is to be applied to all tax returns. If the tax following the AMT formula is greater than the regular tax, then the taxpayer will pay tax under the AMT formula. A Head of Household taxpayer making $60,000 of gross income with 5 children under age 17 will pay tax under the AMT formula (personal exemptions are not included in the AMT formula). Family lawyers will need to better understand the AMT because it is going to start to impact many more divorce settlements than in the past. (FinPlan’s Divorce Plannerâ software automatically computes the AMT but explaining this to clients is going to be a problem for many attorneys).

The Tax Act of 2003 increased the exemption amount for the Alternative Minimum Tax slightly. There is an increasing problem with the AMT because the regular tax rates are significantly lower than the initial 26% AMT rate. The lowering of the regular tax rates without also lowering the AMT tax rates is going to cause many more individuals to be caught in this tax trap. In divorce, there will be many instances in which the AMT is going to reduce or even eliminate the favorable tax savings from alimony created by the different tax brackets of the parties. This is going to show up in cases where the individuals after the alimony have taxable incomes from $75,000 for Head of Household to over $400,000 for a Single filer. The rate reductions from the 2003 Tax Act are going to be negated by the AMT and you should expect this to happen in high income cases especially where state and local tax rates are high (state and local taxes are not an allowed deduction for the AMT). I suggest you discuss this with the financial professional who assists you in higher income cases.