Loan Income: Post-Divorce, Whose Money Is It Anyway?

Divorce can be a messy process, and when children are involved, it can be even more challenging. One of the critical aspects to consider is how the divorce will impact the child's financial prospects, especially regarding education. In the context of student loans, the type of loan, federal or private, and the specific loan program, can significantly influence the outcome. For instance, federal loans like the Federal Direct Loan Program offer low-interest, fixed-rate loans to students and their parents, while Parent PLUS Loans offer refinancing options to make payments more manageable after a divorce. Additionally, the financial aid forms, such as the Free Application for Federal Student Aid (FAFSA) and the College Scholarship Service (CSS) Profile, treat the finances of divorced parents differently when determining a student's financial aid package. The FAFSA primarily considers the finances of the parent who provides the most financial support, while the CSS Profile often takes into account the income and assets of both parents' households. Understanding these nuances is crucial for divorced parents navigating the complex world of student loans and financial aid for their children.

Does parent income loan count as income after divorce?

Parent PLUS Loans

If you want access to additional repayment plans after a divorce, you can consider using the Parent PLUS double consolidation loophole. This strategy can allow your payments to be capped at only 10% to 15% of your income. However, it can be tedious as you will need to do the research yourself, and it is only available until July 2025. After that date, the Department of Education will close the loophole.

Another option to make Parent PLUS Loans more manageable after a divorce is to take out a Direct Consolidation Loan to become eligible for the ICR plan. Under this plan, your student loan payments are a small portion of your discretionary income (typically 20%). Additionally, if you have a remaining balance at the end of the repayment period, it will be forgiven.

Child support

Net Income Calculation

Net income for child support is calculated by determining the income of the supporting parent from all sources and then subtracting specific deductions, such as health insurance premiums and taxes. The precise definition of "income" can vary and may include salaries, wages, commissions, bonuses, rents, dividends, pensions, interest income, and more. It is important to note that gifts are generally not considered income for the parent who receives them, unless they are provided regularly by the non-custodial parent.

Student Loans and Child Support

When it comes to student loans, the treatment of these funds in a divorce can vary. In Washington State, student loans are typically factored into a person's income, and a court will examine the financial affidavits of both parents, including all types of income. However, in California, student loans used for books and tuition are not considered income for child support purposes.

Public Assistance Programs

Public assistance programs, such as Medicaid and TANF, have their own approach to handling child support. If you receive these benefits, your child support payments may be redirected to the state to reimburse it for the assistance provided.

Student loans

The same logic applies to scholarships and grants. If you use scholarship or grant money for anything other than tuition, books, and supplies, you will need to pay taxes on that amount. Additionally, if you receive a scholarship or grant in exchange for teaching, research, or other services, that money is considered a payment for services rendered and therefore counts as income.

In the context of divorce, student loans, specifically Parent PLUS Loans, are usually not considered marital debt. However, if you live in one of the nine community property states, including Arizona, California, and Texas, assets and debts may be divided equally during a divorce, making both parties liable for the debt. To make Parent PLUS Loans more manageable after a divorce, you can consider taking out a Direct Consolidation Loan to become eligible for the ICR plan, which caps payments at a small portion of your discretionary income. Alternatively, you can refinance your Parent PLUS Loans through companies like Laurel Road, potentially securing a lower interest rate.

Tax implications

Divorce brings about several changes in how you file your taxes. Your filing status, standard deduction, eligibility for certain credits, and tax are all determined by your filing status, which is usually based on whether you are married or unmarried at the end of the year. The IRS considers you married for filing purposes until you obtain a final divorce decree or separate maintenance order. You must file as single for that tax year unless you remarry by the end of the year or are eligible to file as head of household.

If you receive alimony, you may need to adjust your withholding or make estimated tax payments. Payments made to a spouse under a divorce or separation agreement may be considered alimony or separate maintenance. The tax treatment of these payments depends on the specifics of your agreement. If your agreement was signed in 2019 or later, payments are not deductible by the paying spouse and are not included in the receiving spouse's income. However, if your agreement was signed in 2018 or earlier, payments are deductible by the paying spouse and are included in the receiving spouse's income.

Child support payments are neither deductible by the payer nor taxable to the payee. If you have dependent children and are divorcing, you may be concerned about who will receive the Child Tax Exemption and the Child Care Credit. According to IRS rules, the custodial parent, who the child lives with the majority of the time, is typically eligible for the exemption. However, this rule often changes in divorce situations, and parents may agree to alternate exemption years.

Retirement plans and divorce can have tax implications. If you participate in a retirement plan and get divorced, your ex-spouse may become entitled to a portion of your account balance under a qualified domestic relations order (QDRO). If you receive payments under a QDRO, they are generally included in your income unless you meet certain conditions by rolling them over into a traditional IRA. If you withdraw amounts from your traditional IRA to pay your ex-spouse as part of your divorce settlement, those amounts are taxable to you. Additionally, you cannot deduct contributions you make to your former spouse's traditional IRA after a divorce or legal separation.

Loans from family members can have tax implications. While the IRS is generally not concerned with small loan amounts under $10,000, larger sums can trigger gift tax implications if not handled properly. If you lend money to a family member and do not charge interest, the IRS may consider the amount of interest you should have charged as a gift, subject to the annual gift-giving limit of $18,000 per individual as of 2024. If you give more than this amount, you must file a gift tax form. On the other hand, if you charge interest, you must ensure it is at least the minimum interest rate based on the applicable federal rates (AFRs) or the borrower's net investment income for the year. If you charge an interest rate below the AFR, it is considered a below-market loan, and there may be additional tax implications.

Custody

Custodial Parent's Responsibilities and Benefits

The custodial parent, or the parent with whom the child lives most of the time, is responsible for completing the Free Application for Federal Student Aid (FAFSA). This is a critical form for determining financial aid eligibility for college. The custodial parent is typically the one who provides the most financial support to the child. In cases of equal 50-50 custody, the parent with the higher income is usually considered the custodial parent.

Non-Custodial Parent's Responsibilities and Benefits

While the non-custodial parent's income and assets are not considered by the Federal government when determining a student's financial need, they may still be required to provide financial support for their child's college education. Many private colleges consider the non-custodial parent as a potential source of support and may require additional financial aid forms. Additionally, in the context of tax benefits, the non-custodial parent can claim the child as a dependent if the custodial parent signs a release or a similar declaration.

College Support Agreements

It is highly recommended that divorced parents prepare a written college support agreement, outlining their financial responsibilities for their child's college education. This agreement can specify how college costs will be divided between the parents, whether there are any conditions for the child to continue receiving support (such as maintaining a certain GPA), and how the support will be paid out (directly to the school, to the custodial parent, or to the child).

Stepparents' Responsibilities and Benefits

The financial support provided by a stepparent who has not adopted their stepchild is generally not considered untaxed income to the student on the FAFSA. However, if a stepparent is the legal spouse of the custodial parent, their financial information may need to be included on the FAFSA.

In summary, custody arrangements significantly impact the financial responsibilities and benefits of both the custodial and non-custodial parents, particularly regarding college financial aid and tax benefits. It is essential for divorced parents to understand these nuances to ensure they are fulfilling their obligations and maximizing their children's opportunities for financial support.

Frequently asked questions