by Bob Rywick
Whether a married couple should file a joint income tax return or separate returns will usually depend upon which filing status will result in the lowest tax. Both federal and state income taxes should be taken into account in making this decision.
Filing jointly usually will offer the most tax savings if one of the spouses has no income or has substantially less income than the other spouse has. This is because part of the income of the spouse with greater earnings will be brought down into a lower tax bracket if they file a joint return.
Example 1: Your client expects to have adjusted gross income of $100,000 in 2003, and expects her husband to have AGI of $25,000 in the same year. Your client will have itemized deductions of $20,000 and her husband will have itemized deductions of $5,000. And each will be entitled to a personal exemption of $3,050.
If they file separately, your client will have taxable income of $77,858 (AGI of $100,000, less itemized deductions of $19,092 [$20,000 less $908 (3 percent of $30,250, the excess of $100,000 over $69,750, the amount at which itemized deductions start to be phased out in 2003 on a separate return)] and less personal exemption of $3,050).
Your client will owe federal income tax of $18,491 for 2003. Her husband will have taxable income of $16,950 (AGI of $25,000, less itemized deductions of $5,000 and less personal exemption of $3,050). He will owe federal income tax of $2,243. Their combined federal income taxes for 2003 will be $20,734 ($18,491 plus $2,243).
If they file a joint return for 2003, their combined taxable income will be $93,900 (combined AGI of $125,000, less combined itemized deductions of $25,000, and less two personal exemptions totaling $6,100). Their tax on a joint return will be $19,061, or $1,673 less than they would pay if they filed separate returns.
In effect, part of your client’s income that would otherwise be taxed at a 30-percent rate if separate returns were filed will be taxed at a 27-percent rate if a joint return is filed. Also, there will be no phaseout of any part of their itemized deductions, since the phaseout range on a joint return starts at AGI of $139,500 in 2003.
If both spouses have substantially equal amounts of income, their federal income taxes usually will be about the same, regardless of whether they file separate returns or a joint return, although there may be some state tax savings if separate returns are filed (see below).
When taxes will be lower if separate returns are filed. There is a potential for tax savings from filing separately where one spouse has significant amounts of medical expenses, casualty losses or “miscellaneous itemized deductions” that are deductible only if they exceed a percentage of the AGI floor.
Medical expenses are deductible only to the extent that they exceed 7.5 percent of AGI, casualty losses must exceed 10 percent of AGI, and miscellaneous itemized deductions must exceed 2 percent of AGI. (Miscellaneous itemized deductions include a variety of deductions, such as investment expenses other than investment interest, unreimbursed employee expenses, and tax return preparation costs.)
If these deductions are isolated on the separate return of a spouse, that spouse’s separate AGI, as compared to the higher joint AGI, can result in larger total deductions. In some cases, each spouse may get higher deductions by filing separate returns, e.g., one may be able to deduct a higher amount of miscellaneous itemized deductions on a separate return, and the other may be able to deduct a higher amount of medical expenses.
Example 2: Your client expects to have AGI of $100,000 and miscellaneous itemized deductions of $4,500 in 2003. He will have no unreimbursed medical expenses. His wife expects to have AGI of $80,000, unreimbursed medical expenses of $12,000, and miscellaneous itemized deductions of $500. They will have other itemized deductions totaling $16,000 that are not subject to any percentage of AGI floor, and that would be divided evenly between them if they file separate returns. They have no dependents.
If your client and his wife file a joint return for 2003, their total AGI will be $180,000. Their total itemized deductions will be $16,185, computed as follows:
● Itemized deductions of $16,000, not subject to a floor; plus,
● $1,400 of miscellaneous itemized deductions ($5,000 total miscellaneous itemized deductions less $3,600 [2 percent of AGI of $180,000]); less,
● $1,215 (3 percent of $40,500, the excess of AGI of $180,000 over $139,500 [amount at which itemized deductions start to be phased out in 2003 on a joint return]).
Note that they are not entitled to any deduction for medical expenses, since the $12,000 of medical expenses is less than $13,500 (7.5 percent of their AGI of $180,000).
Their total taxable income, if they file a joint return, will be $157,715 (AGI of $180,000, less itemized deductions of $16,185, less personal exemptions of $6,100). Their federal income tax on taxable income of $157,715 will be $37,581.
If they file separate returns, their federal income taxes will be computed as follows: Your client will have taxable income of $87,358 (AGI of $100,000, less itemized deductions of $9,592, less personal exemption of $3,050). The federal income tax on this amount for 2003 will be $21,341.
Your client’s itemized deductions equal $8,000 (his half of itemized deductions not subject to a floor), plus $2,500 of miscellaneous itemized deductions ($4,500 less $2,000 [2 percent of AGI of $100,000], less $908 [3 percent of excess of $100,000 over $69,750 (the amount at which itemized deductions start to be phased out in 2003 on a separate return)]).
Your client’s wife will have taxable income of $63,258 (AGI of $80,000, less itemized deductions of $13,692, less personal exemption of $3,050). The federal income tax on this amount for 2003 will be $14,111.
Your client’s itemized deductions equal $8,000 (his half of itemized deductions not subject to a floor), plus $6,000 of medical expenses ($12,000 less $6,000 [7.5 percent of AGI of $80,000], less $308 [3 percent of excess of $80,000 over $69,750]).
If they file separate returns, their total federal income taxes for 2003 will be $35,452 ($21,341 for your client plus $14,111 for his wife), or $2,129 less than what they would have to pay if they filed a joint return ($37,581 less $35,452).
Observation: In Example 2, by filing separate returns instead of joint returns, your clients were able to increase their total itemized deductions by $7,100 ($6,000 of medical expenses compared to none if a joint return was filed, and $2,500 of miscellaneous itemized deductions compared to $1,400).
Caution: Other tax factors may point to the advisability of filing a joint return. For example, the child and dependent care credit, adoption expense credit, Hope and Lifetime learning credits, and the deduction for higher education expenses are available to a married couple only on a joint return.
Also, the credit for the elderly or the disabled can’t be taken on separate returns unless the spouses lived apart for the entire year. Nor can spouses deduct qualified education loan interest unless a joint return is filed. A spouse may not be able to deduct contributions to an IRA if either spouse was covered by an employer retirement plan and they file separate returns. Nor can adoption assistance payments or any interest income from series EE savings bonds used for higher education expenses be excluded if separate returns are filed. In addition, Social Security benefits may be more heavily taxed to a couple that files separately.
Effect of state tax rules. Some states, e.g., New York, allow you to file separate returns only if you file federal separate returns. Separate returns may be beneficial in some states because each spouse will be taxed the same as a single taxpayer, i.e., there would be no marriage penalty if separate returns are filed. Thus, even if you don’t save any federal income tax by filing separate federal returns, the state taxes you save may make it worthwhile for you or your clients to file separate federal returns.
In some situations, it may be worthwhile to file separate federal returns, even if this results in a small increase in federal income taxes, if the only way you can file separate state returns will be to file separate federal returns.
In other states, it may not be advantageous to file separate returns even if it is advantageous to do so for federal income tax purposes. You have to check both the law and the facts carefully to see if your clients would benefit from filing separate state returns.
Joint and several liability if spouses file a joint return. If spouses file a joint return, each of them is jointly and severally liable for the tax on their combined income, including any additional tax that the IRS assesses, plus interest and most penalties. This means that the IRS can come after either of them to collect the full amount. Although there are provisions in the law that offer relief from joint and several liability, each of those provisions has its limitations.
Thus, even if a joint return results in less tax, there may be situations where one of the spouses may want to file a separate return, e.g., if he isn’t sure about the validity of some of the information with regard to income or deductions being provided by the other spouse.
