The Tax Play That Saves Some Couples Big Bucks. Married, Filing Separately

This Week's Quote:

“There is nothing impossible to they who will try.”
                                  - Alexander the Great

Spencer Phillips, a 39-year-old orchestral musician who plays the bass violin, loves and trusts his wife of 10 years—but he refuses to file a joint income-tax return with her. 

Instead, Dr. Phillips and his wife opt into the “married, filing separately” status, called MFS, and each spouse reports only his or her income to the Internal Revenue Service. This saves them a lot of money: By filing separately and so reducing his stated income, Dr. Phillips’s student-loan payments on about $200,000 of debt, for a doctorate from the prestigious Eastman School of Music and other programs, come to about $240 monthly instead of more than $1,000.  

“This is a huge help to us and other artists, and it’s legal,” says Dr. Phillips, who adds that he is super-aware of tax rules because he has three IRS agents in his family.   

Dr. Phillips and his wife are part of a growing number of married couples who file separate tax returns. For the decade ending in 2020, the IRS’s latest available data, the number of married-filing-separately filers rose from 2.6 million to 3.9 million annually. While some of that growth was due to couples filing separately to qualify for pandemic benefits, there was a large increase before then. 

Still, couples in this category were a tiny fraction of the 55 million who filed jointly, in part because choosing MFS precludes some tax breaks and complicates others. But the growth spurt for MFS invites a look into why taxpayers choose this status.

One longstanding reason is still among the most common, say tax advisers. Choosing MFS severs joint liability, meaning each spouse isn’t responsible for the information on the other’s return. This can be a deciding factor for some couples who are separated but not divorced and others who don’t want to commingle finances, even if it raises their taxes.

Other couples opt into MFS because it reduces their tax bill. For example, unreimbursed medical expenses are only deductible above 7.5% of income. So if one spouse has large unreimbursed medical expenses, filing separately could lower the income of the spouse with the expenses and provide a larger deduction. 

Two new factors are likely boosting the trend. More than nine million borrowers with student loans now participate in income-driven loan-repayment programs, according to research by The Pew Charitable Trusts. These borrowers pay a percentage of monthly income toward their loans, with the aim of having the remaining debt forgiven after a term of years. Married borrowers in these programs are allowed to file separately to lower their income. 

Dr. Phillips’s loans are this type, with most of them in special “public-service” programs for borrowers working at nonprofits in areas like medicine, law, or the arts. Currently he pays 15% of his disposable income toward these loans, with the remainder to be forgiven (tax-free) after 10 years.  

Business owners also have an incentive to use MFS due to a key break enacted in the 2017 tax overhaul. Known as QBI—for qualified business income—it allows eligible business owners to deduct up to 20% of their business income on their individual returns. But to avoid limits, the owner’s 2023 taxable income must be below $182,100 for single or MFS filers, or $364,200 for couples filing jointly.   

This means that filing separately can save taxes for affluent two-income couples in which one spouse owns a business, says Adam Markowitz, a tax professional near Orlando, Fla. 

“The QBI deduction can be too valuable to lose, even if a filer gives up other tax breaks,” he adds. 

Married couples considering filing separately should run the numbers. MFS doesn’t treat two spouses like unmarried single filers, and there are pitfalls. Here are pointers to keep in mind, and see IRS Publication 501 for more details.      

Know what’s different for MFS filers

By law, married couples filing separately can’t take certain tax breaks. These include the American Opportunity and Lifetime Learning education credits; the child- and dependent-care credit; and the student-loan interest deduction. A greater percentage of Social Security benefits can be taxable.

In addition, contributions to traditional and Roth IRAs are affected. For example, MFS filers typically can’t contribute directly to a Roth IRA if they have more than $10,000 of income. But often the saver has a workaround by making a nondeductible contribution to a traditional IRA and then doing a backdoor Roth conversion.   

Other tax benefits are split down the middle, with each spouse getting half. This applies to the standard deduction, the deduction of up to $10,000 for state and local taxes, the home-sellers exemption and the deduction of up to $3,000 of net investment losses against ordinary income.    

Be aware of quirks

Married couples are allowed to switch between filing separately for some years and jointly for others, and MFS filers can also later amend tax returns to claim joint status. However, joint filers usually can’t amend returns to file separately. 

If one spouse itemizes deductions on Schedule A, then the other must typically itemize as well. 

On Medicare? Be careful.

It might seem like a good idea to file separately in order to boost the deduction if one spouse has, say, substantial nursing-home expenses. However, MFS status can substantially raise IRMAA (income-related monthly adjustment amount) payments for Medicare Parts B and D because MFS filers have fewer IRMAA brackets.

Casey Schwarz, a senior counsel with the Medicare Rights Center, notes that the maximum IRMAA increase above the base premium is about $9,400 per couple, per year. For Medicare users with higher incomes, the difference would be less and filing separately could be cost-efficient for some. So run the numbers. 

Check state-tax implications

Many states require tax filers to use the same status for the state return as the federal return, according to the Tax Foundation. Filers in community-property states should also determine how state law affects federal returns using MFS status. The filer may need to submit IRS Form 8958 detailing the allocation of income and taxes between spouses. 

Damien Martin, a tax partner with EY in Chicago, pays close attention to separate-filing opportunities for state taxes. In one case, a couple reaped substantial savings by having one spouse file separately for Illinois and the other, who was retired, claim residence in Florida. They filed jointly on the federal return.

Corrections & Amplifications
Married couples who file separately can amend tax returns to claim joint status, while those that file jointly usually can’t amend returns to file separately. An earlier version of this column incorrectly said that joint filers can amend tax returns to claim separate filing status and that those that file separately usually can’t amend returns to file jointly. (Corrected on March 3)

Appeared in the March 4, 2023, print edition as 'The Tax Play That Saves Some Couples Big Bucks'.

 
Credit goes to Laura Saunders, published March 4, 2023 in the Wall Street Journal.

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This Week’s Author, Belinda Stickle

-until next week