With limited exceptions, the tax on married couples filing jointly usually has been lower than the combined tax on married couples filing separate returns.
However, as a result of changes in the tax law that caused the end-point of the 15 percent bracket for married couples filing jointly to be twice the end-point of the 15 percent bracket for a single filer or a married person filing separately, and the standard deduction for a married couple filing jointly to be twice the standard deduction of a single person or a married person filing separately, a married couple's tax often will be the same whether they file jointly or separately.
Thus, if there is a shaky marriage or a spouse has questionable tax items, there may now be greater occasion to file separately than in the past, because, in many cases, filing separately may no longer involve an increased tax cost or may only involve a slightly or moderately increased tax cost.
Joint filing usually will still produce lower taxes for higher-income couples, since the "marriage penalty" is still in effect for income brackets above 15 percent. Also, some tax breaks are either unavailable or are less favorable when separate returns are filed.
This article discusses whether a joint return or separate returns should be filed, taking into account the marriage penalty relief in effect for lower-income taxpayers, as well as the other rules that differ depending on whether a joint return or separate returns are filed.
When you have the option of filing joint or separate returns. A married couple may not file a joint return but must file separate returns if:
* Either spouse is a nonresident alien at any time during the year (but a joint return may be filed if the nonresident spouse elects to be treated as a resident alien so that all of his worldwide income will be subject to U.S. tax); or,
* They have different tax years (but not if the different years result from the death of one of the spouses).
If neither exception applies, the married couple has the option of filing separate returns or a joint return.
The amount of tax owed is not the only factor to consider in determining whether to file jointly or separately. Whether to file a joint return or separate returns usually depends upon which filing status results in the lowest tax.
Observation: In determining whether lower taxes will result from filing a joint return or separate returns, state and local taxes should be considered along with federal taxes. In some cases, federal taxes may be slightly higher if separate returns are filed, but the higher federal tax will be more than offset by lower state and local taxes. This is especially so if there is no marriage penalty at the state and local level while the penalty remains in effect at least partially at the federal level.
However, lower taxes aren't the only item that a couple should consider in deciding whether to file separately or jointly. The couple also should realize that if they file jointly, each spouse would be jointly and severally liable for the tax on the combined income, including any additional tax that the Internal Revenue Service assesses (including interest and most penalties).
In other words, the IRS can go after either spouse to collect the full amount, unless a spouse is able to establish qualification for innocent spouse relief. This is so even if the parties subsequently divorce and the divorce decree says that one spouse is liable for the tax shown on the joint return. Thus, if an individual does not want to be potentially responsible for the tax of the other spouse, the individual should consider filing a separate return, even if more tax would be owed by the couple.
The pros of filing jointly
In most cases, filing jointly offers the most tax savings. This is especially so if the spouses have different income levels. By combining the two incomes, some of the income of the higher-income spouse may be taxed in a lower tax bracket.
Example 1: Your clients are a married couple without any other dependents. Neither the husband nor the wife is over 65. However, the husband is retired and his adjusted gross income if he files a separate return for 2004 would be $20,000. His wife's AGI on a separate return for 2004 would be $80,000. They claim the standard deduction.
If he files a separate return, his taxable income would be $12,050 ($20,000 less personal exemption of $3,100 and standard deduction of $4,850). The federal income tax on $12,050 would be $1,446. His wife's taxable income would be $72,050 ($80,000 less personal exemption of $3,100 and standard deduction of $4,850). The federal income tax on $72,050 would be $15,060. Their combined taxes from filing separate returns would be $16,506 ($1,446 plus $15,060).
If they file a joint return, their combined taxable income on that return would $84,100 (combined AGI of $100,000 less standard deduction of $9,700 and two personal exemptions totaling $6,200). The tax on $84,100 for joint filers is $14,506, or $2,000 less than the total of $16,506 that they would have to pay filing separate returns.
Observation: In Example 1, by filing joint returns, your clients were able to pull some of the taxable income of the wife that would be taxed in the 28 percent and 25 percent tax brackets on a separate return into the 10 percent and 15 percent tax brackets.
If each spouse had about the same amount of taxable income, absent special factors eliminating or reducing tax breaks for separate filers (see below), the tax would be almost the same on either a 2004 joint return or on separate returns.
Example 2: The same facts apply as in Example 1, except that each spouse had AGI of $50,000. If they filed separate returns, each would have taxable income of $42,050 ($50,000 less standard deduction of $4,850 and personal exemption of $3,100). The tax on $42,050 would be $7,256, for a combined tax of $14,512 or only $6 more than the $14,506 that would be owed on a joint return (see Example 1).
Observation: In Example 2, the slightly higher tax if separate returns are filed results from the way that the tax tables are rounded. If the tax rates were used to calculate the tax, the tax would be identical regardless of whether your clients filed separately or jointly.
The pros of filing separately
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. This is because of the rules that reduce these deductions by a percentage of AGI. If these deductions are isolated on the separate return of a spouse, that spouse's lower AGI, as compared to the higher joint AGI, can result in larger total deductions.
Example 3: Your clients are a married couple with a combined AGI of $100,000. Of this amount, $30,000 is attributable to the wife, and $70,000 to the husband. The wife also has unreimbursed medical expenses of $6,500 and the husband has unreimbursed medical expenses of $500. If they file a joint return, they will not be able to claim any itemized deduction for medical expenses, since their total medical expenses of $7,000 do not exceed $7,500 (7.5 percent of their combined AGI of $100,000).
However, if they file separate returns, the wife will be able to claim an itemized deduction of $4,250 for medical expenses ($6,500 less $2,250 [7.5 percent of the wife's AGI of $30,000]). If they file separate returns, both must itemize, i.e., the husband could not claim the standard deduction on a separate return if his wife itemizes on her separate return.
Other key tax factors
The following are other key tax factors to consider in deciding whether to file jointly or separately:
1. The child and dependent care credit, adoption expense credit, and Hope and Lifetime Learning credits are available to a married couple only if they file a joint return.
2. Married individuals generally file a joint return to claim the Earned Income Tax Credit.
3. The deduction for higher education expenses is available to a married couple only on a joint return.
4. Credit for the elderly or disabled is not available on separate returns unless the spouses lived apart for the entire year.
5. Qualified education loan interest is not deductible on separate returns.
6. A spouse cannot exclude adoption assistance payments or any interest income from Series EE savings bonds used for higher education expenses if separate returns are filed.
7. Social Security benefits may be more heavily taxed to a couple that files separately, since the base amount at which those benefits are taxed on a separate return starts at $0 instead of at $32,000, as it does on a joint return.
8. Individuals who file a joint return cannot be claimed as dependents on another return. This can be important when married students are still supported by their parents.
9. The exclusion of gain on the sale of a principal residence is limited to $250,000 on a separate return. It's $500,000 on a joint return.
Observation: This is important only if the property is owned by only one of the spouses. If they own the property jointly, each can exclude up to $250,000 of their share of the gain on a separate return.
10. Dependency exemptions for a taxpayer who is supporting one or more of her spouse's relatives may be disallowed for relatives who do not live with the spouse providing the support. The relationship or member-of-household test for dependency exemptions must be met personally by the spouse filing a separate return.
11. The $25,000 passive activity loss exception for actively managed rental real estate is halved on a separate return and one spouse's passive activity income may not be offset by the other spouse's passive activity losses on a separate return.
12. The phase-out of IRA deductions or contributions to a Roth IRA cannot be avoided by filing separate returns if the spouses lived together during the tax year. When filing separately, the modified AGI phase-out range for making such contributions ends at $10,000. In addition, contributions to an IRA that are allowed because of a spouse's compensation are not available to separate filers.
13. The limit on the capital loss deduction on a separate return is $1,500; otherwise, it's $3,000.
Observation: This is important only if one spouse has more than $1,500 in capital losses and the other spouse has less than that amount.
14. A traditional IRA cannot be converted to a Roth IRA in a year separate returns are filed.
15. Married taxpayers who file separate returns and whose alternative minimum taxable income exceeds $191,000 have their $29,000 (for 2004) AMT exemption completely phased out. In addition, they must add an additional amount (up to the exemption amount) to their AMTI.
16. When the parents of a child who is subject to the kiddie tax file separate returns, the greater taxable income of the two parents is used when computing the child's tax. This may result in the child's income being taxed at a higher rate than in a joint return.
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