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Is it Better for Couples to File Joint or Separate Tax Returns?

The Marriage Penalty

Our clients often ask whether they should file joint or separate tax returns with their spouse. Unfortunately, the answer is generally “well, it depends”.  While it is usually most beneficial to file a joint return, there are a few notable exceptions where filing separate returns may be advantageous.

Typically, when a couple combines their income and deductions, they fare better by filing a joint return on the federal level, especially if one spouse has significantly more income than the other spouse. The way the tax brackets are structured can work against you if you elect to file separately, especially in the case of upper-income taxpayers.  On occasion, in a situation where each spouse earns  roughly the same amount, the so-called “marriage penalty” can affect the results, forcing some couples to pay more tax on a joint return than they would owe if they were each single filers. However, recent tweaks in the tax brackets have reduced the impact of the marriage penalty and  filing jointly is usually still preferable to filing separately as a married couple.

Despite these caveats, in certain situations filing separately may be beneficial, for example, when there is a large disparity between incomes of the spouses. This may result in a combined lower tax situation, but usually only in separate (non-community) property states. In some instances, filing separately will produce better overall tax results if one spouse has a disproportionate share of deductions subject to one of the tax law’s floors, such as medical or miscellaneous expenses, or significant unreimbursed business expenses. One example would be if Betty and Joe are married and each one is age 65. Joe still works full-time and has an adjusted gross income (AGI) of $150,000 a year while Betty is a part-timer with an AGI of $10,000. In 2014, Joe had only $1,000 in deductible medical expenses. However, Betty had expensive surgeries and paid out-of-pocket medical expenses of $9,000. If the couple files a joint return, they get no medical expense deduction. Their total of $10,000 in expenses doesn’t exceed 7.5 percent of their combined AGI of $160,000. (The AGI floor is 10 percent for younger filers.) However, if they file separate returns, Betty would be entitled to a medical expense deduction of $8,250 (the excess over 7.5 percent of her AGI of $10,000).

Another reason to file separate returns is when you need to separate your tax liability from your spouse or if there is concern that one spouse isn’t being honest. If you file separately, you will only be responsible for the accuracy and payment of taxes for your own return. With a joint return, both spouses are jointly and severally liable on a joint return that they sign. Although “innocent spouse” relief may be granted if certain requirements are met, this is often difficult to prove so in this type of unfortunate situation, it may be better to file separately.

Despite these potential benefits, taxpayers should understand that there are several drawbacks to choosing the married filing separately option. For example, you could forfeit tax benefits overall by splitting up deductions and credits. Furthermore, certain credits – such as the Earned Income Tax Credit (EITC), adoption credit or dependent care credit – aren’t available to marrieds filing separately. In addition, this election could have a negative impact on capital gain or loss treatment. As a result, certain short-term gains may be taxed at high ordinary income tax rates or losses might not offset high-taxed gains. In addition, complications may arise relating to state income taxes. In particular, residents of community property states — Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin – could face undesired tax consequences.

Other potential issues with electing Married Filing Separate include:
• Married Filing Separately limits deductions and credits
• Taxpayers have a much lower income phase-out range for IRA deductions.
• Both spouses must claim the standard deduction, or both must itemize their deductions. One spouse cannot claim the standard deduction if the other is itemizing
• This filing status generally pays the most tax of all the filing statuses.
• Married Filing Separately (MFS) taxpayers are only responsible for their income and taxes (and not for a spouse), but may not be eligible to claim the following tax benefits:
o Tuition and fees deduction
o Student loan interest deduction
o Tax-free exclusion of US bond interest
o Tax-free exclusion of Social Security Benefits
o Credit for the Elderly and Disabled
o Child and Dependent Care Credit
o Earned Income Credit
o Education Credits

So how should taxpayers determine the best election for their particular situation? The optimal approach is to calculate things out both ways, including a complete analysis on both federal and state taxes, before making the final choice on Form 1040. Your Hysjulien and Associates tax professional will then advise you on the best and most advantageous method of filing your tax return.

March 18th, 2015

Posted in Advisory,Featured,Tax

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