Married and tax-savvy: evaluating your filing options
ARTICLE | August 02, 2023
When considering the best approach to filing taxes, many married couples opt for the "Married Filing Jointly" status by default and the benefits it may afford. However, filing as "Married Filing Separately" may be beneficial in certain circumstances. In this article, we'll discuss the top considerations when choosing the optimal filing status for your situation.
When it comes to filing your taxes as a married couple, whether you choose to file jointly or separately, there are several basic considerations to keep in mind.
Consistency in deduction type
When filing separately, both spouses must use the same type of deduction - either itemizing or taking the standard deduction. For example, if one spouse itemizes deductions, the other cannot claim the standard deduction and must also itemize, even if their itemized deductions are less than the standard deduction.
Impact of state laws
It's also essential to consider the impact of state tax laws. In community property states - Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin - income and deductions are typically split 50/50. So, even if you're filing separately, you may have to report half of your total community income and deductions.
Social Security benefits
If you receive Social Security benefits, a portion of your benefits may be taxable, depending on your total income and marital status. The IRS uses a formula to determine how much of your Social Security benefits are taxable. When you file jointly, up to 85% of your Social Security benefits may be considered taxable income if your combined income is above $32,000.
However, if you file separately and lived with your spouse at any time during the year, 85% of your Social Security benefits are taxable, regardless of your income.
When filing jointly makes sense
Opting for a "Married Filing Jointly" (MFJ) status can yield substantial benefits for many couples. Here are some key areas where filing jointly can offer advantages:
Lower combined tax liability
One of the primary benefits of filing jointly is the potential for a lower combined tax liability. This can be particularly true if there is a considerable disparity in income between spouses. The tax brackets for joint filers are more favorable than those filing separately, often resulting in a lower overall tax rate.
For instance, suppose Spouse A has a taxable income of $300,000 while Spouse B has a taxable income of $150,000. Spouse A would fall into the 35% bracket if they were to file separately, owing approximately $76,895 in federal income taxes (for 2023). Spouse B would fall into the 24% bracket, owing roughly $29,400 - leading to a combined tax liability of $106,295.
However, if they file jointly, their combined taxable income is $450,000, and they would fall in the 32% tax bracket. This would equate to a total tax liability of $101,664 (for 2023), saving them more than $4,600 than if they filed separately.
Broader range of tax credits and deductions
Filing jointly often provides married couples access to a wider array of tax benefits and credits. Some of these benefits are reduced or not available if they file separately. These include the Earned Income Tax Credit, Child Tax Credit, Child and Dependent Care Credit, Adoption Credit, American Opportunity Credit, Lifetime Learning Credit, Student Loan Interest Deduction, and Tuition and Fees Deduction.
For example, the Child Tax Credit can provide a credit of up to $3,000 per qualifying child under age 18 (or $3,600 if under age 6) for couples filing jointly with a modified adjusted gross income (MAGI) of up to $150,000. If they filed separately, the MAGI phase-out limit for this credit starts at $75,000, which may significantly reduce the credit's value or eliminate it altogether.
Retirement account savings
The rules regarding deductions for contributions to employer-sponsored retirement plans and traditional Individual Retirement Accounts (IRAs) are complex and depend on a variety of factors, including income, filing status, and whether the individual or their spouse is covered by a workplace retirement plan.
Contributions to employer-sponsored plans like 401(k)s are typically made with pre-tax dollars, regardless of your filing status. This means the income you contribute to these plans is not subject to federal income tax in the year of the contribution. The advantage of filing jointly isn't usually about a higher deduction limit but about the ability to contribute to these plans at all. For example, if a spouse isn't earning income, they can't contribute to an IRA unless they file jointly. When married filing jointly, the working spouse can make a contribution to an IRA on behalf of the non-working spouse, which can provide additional tax advantages for the couple.
Also, by filing jointly, couples have a higher income threshold before their ability to deduct contributions to a traditional IRA begins to phase out. This is because the deduction you can take for contributions to a traditional IRA depends on your modified adjusted gross income (MAGI) and your filing status.
For 2023, if you're covered by a retirement plan at work, the deduction for contributions to a traditional IRA is phased out if your MAGI is:
More than $116,000 but less than $136,000 for a married couple filing a joint return.
More than $0 but less than $10,000 for a married individual filing a separate return.
Therefore, by filing jointly, couples can have a much higher income before their ability to deduct contributions to a traditional IRA begins to phase out.
When filing separately makes sense
There are also instances where filing separately may be the more prudent option. Here are some circumstances where filing separately could prove advantageous:
Potential tax liabilities
One of the key reasons some couples choose to file separately is the individual responsibility it offers for tax liabilities. When you file separately, you are only accountable for the accuracy of your tax return and not that of your spouse. This can be particularly relevant if you have concerns about the accuracy of your spouse's tax information or if they have more complicated tax situations, such as owning a business.
For example, suppose Spouse A runs a business and may face audit risks or potential tax debts due to the complexity of business-related tax filings. In this case, Spouse B might file separately to avoid potential liability linked to Spouse A's business.
It's important to note that depending on the type of taxes owed, the IRS could still place a lien on the couple's joint property, such as their primary home - so filing separately isn't necessarily a "get out of jail free card" for tax debts in all situations.
Disparate incomes and itemized deductions
In certain situations, it might be beneficial to file separately if one spouse has substantial medical expenses or casualty losses. To qualify for these deductions, they must exceed a certain percentage of your adjusted gross income (AGI).
For instance, suppose Spouse A earns $200,000 yearly while Spouse B earns $45,000. Spouse B's surgery last year led to $12,000 in unreimbursed medical expenses. The IRS allows for the deduction of unreimbursed medical expenses only if they exceed 7.5% of the filer's AGI. If the couple filed jointly, the deductible threshold would be $18,375 (7.5% of $245.000). As Spouse B's medical expenses do not exceed this amount, they wouldn't be deductible. However, if they filed separately, the threshold for Spouse B would be only $3,375 (7.5% of $45,000). This would allow Spouse B to take a deduction for the expenses exceeding that threshold, assuming Spouse B paid for those expenses.
Income-driven student loans
Filing separately can also benefit those with income-driven student loan repayment plans. While this does not save on taxes, it can help keep your payments low. Income-driven plans calculate monthly payments based on your discretionary income and family size. If you file jointly, both spouses' incomes are considered in this calculation, potentially resulting in higher monthly payments.
For instance, suppose Spouse A has an income-driven repayment plan, and Spouse B has a significantly higher income. If they file jointly, the student loan payments might increase substantially due to the higher joint income. By filing separately, Spouse A could potentially keep their monthly student loan payments lower, as only their income would be considered for the repayment calculation.
However, it's essential to note that this strategy may not be beneficial in the long term, as you could face negative amortization if your income-based payments do not cover the full cost of the interest on the loans. You will also need to compare this strategy to any savings you may lose in the form of student loan interest deductions (which you cannot claim if you file separately).
Separation or divorce
If you are separated or in the midst of divorce proceedings, filing separately might be a more logical option to maintain financial independence and clarity, even if it isn't the most tax-savvy choice. This approach allows each spouse to be solely responsible for their tax situation and can make the financial aspects of the divorce process more straightforward.
Choosing your optimal filing status
Deciding whether to file jointly or separately is a personal decision that should be based on your circumstances. In general, couples with significant income disparities and itemizable deductions by the lower-earning spouse might benefit from filing separately, particularly if they have no dependents or education expenses. However, this can be a complex decision with many moving parts. Here are a few important factors to consider:
1. Compare tax brackets
Comparing the tax brackets for each spouse's income individually and jointly can provide a clearer picture of potential savings or costs.
2. Consider dependents and their impact on your taxes
If you have dependents, such as children or elderly parents, you might be eligible for certain tax credits or deductions, like the Child Tax Credit or Credit for Other Dependents. Most of these benefits are reduced or eliminated when filing separately, which can significantly impact your tax liability.
3. Compare deductions and consider retirement accounts
The tax benefits from certain deductions may vary greatly based on your filing status. As mentioned, one spouse having significant medical expenses may be a factor in deciding your filing status.
Also, consider the potential impact on your retirement accounts. Filing status can influence your ability to contribute to certain retirement accounts and the amount you can deduct for those contributions.
4. Consider the presence of tax liabilities or inaccuracies
The presence of tax liabilities or inaccuracies can significantly impact the decision to file jointly or separately. If you have reason to believe your spouse's tax information may not be completely accurate (or believe they are at higher risk of an audit due to complicated business filings), it might be prudent to file separately to reduce your risk of an audit or responsibility for your spouse's errors or omissions.
5. Compare potential student loan savings
If either or both of you have income-driven student loan repayment plans, filing separately could lower your student loan payments. Keep in mind that while filing separately could lower your monthly payments, it might increase your overall tax liability, so it's essential to weigh the potential savings on student loan payments against the potential increase in taxes.
Speak with your CPA
Making an informed choice about your filing status involves a comprehensive understanding of your financial landscape. Regardless of your circumstances, it's always a good idea to consult with a CPA or tax professional when making decisions about your filing status. Tax laws are complex and change frequently, and a professional can provide personalized advice based on your individual situation.
Also, if you choose to file separately, you can amend your tax return to "Married Filing Jointly" within three years from the due date of the original return. However, the reverse is not true. This is important to keep in mind as you assess your filing options.
This article is intended to provide a brief overview of filing separately vs. filing jointly for married couples. It is not a substitute for speaking with one of our expert advisors. For more information, please contact our office.
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