Too many married folks overpay in taxes by not using this filing status. Are you one of them?
Much of marriage — as any married person will tell you — is about doing things together. You know, as a couple . You buy stuff together: cars, homes, pets, whatever. You socialize together. "We" is the pronoun of choice — not "I." You get the picture.
So it's no surprise that most married folks just assume they should always file their taxes together, too. Not necessarily. In some cases, using married filing separate (MFS) status can significantly reduce your combined tax bill.
You don't need to be a certified public accountant to know that MFS is available only to those who are, well, married . But for those who tied (or untied) the knot in 2003 (meaning those who were both single and married last year), this can be a little confusing.
The first thing to understand is that your marital status for federal income-tax purposes generally depends on whether you were married as of Dec. 31 of the year in question. Say you got married near the end of 2003. As far as the IRS is concerned, you were married for all of last year. So your 2003 tax-filing options are limited to: 1) filing jointly with your spouse by combining your income and deductions for the entire year, or 2) MFS, which requires you and your spouse to file independent returns showing your separate income and deductions for the entire year (more on what "separate" really means in this context later).
Similarly, if you were married at the beginning of last year, you generally retain that tax status for the whole year — unless you were divorced or separated under a decree of separate maintenance (same thing as divorced under the tax rules) as of Dec. 31, 2003. So if you were still hitched on that date, that means your options for 2003 are — once again — generally limited to filing jointly with your spouse or using MFS status.
Isn't Filing Jointly Better?
Assuming you were in fact married at the end of last year, you may think filing jointly for 2003 — as opposed to using MFS status — is the no-brainer choice. Not so fast. Oftentimes, the biggest reason to file jointly is simply because it eliminates the need to track and report each spouse's income and deductions.
Filing jointly usually does lower the tax bill when one spouse earns a healthy amount of income while the other has little or none. That's because the joint-filer tax brackets are exactly twice as wide as the MFS brackets. For example, the 28% federal income-tax bracket for joint filers starts at taxable income of $114,650 for 2003. In contrast, the 28% bracket for MFS filers starts at a mere $57,325 of taxable income. So when one spouse earns quite a bit and the other not so much, filing jointly will usually cut their tax bill. Also, MFS filers are ineligible for several popular tax breaks that could save them dough if they file jointly (more on that later). In these situations, the conventional wisdom is correct, and filing a joint return is the tax-smart move.
When to File Separate Returns
You should always check out the potential advantage of using MFS status whenever: 1) both you and your spouse have taxable income, and 2) at least one of you (preferably the person with the lower income) has significant itemized deductions that are limited by adjusted gross income (AGI).
Basically, AGI is the sum of all your income items (salary, capital gains, dividends, alimony received and so forth) reduced by nonitemized write-offs claimed on page one of Form 1040 (retirement account contributions, alimony paid, job-related moving expenses and so on). When you use MFS status, you must separately calculate your AGI and your spouse's AGI. As you are about to see, this can work to your advantage.
The three most common itemized write-offs that are limited by your AGI level are:
• Medical expenses, which you can deduct only to the extent they exceed 7.5% of AGI.
• Uninsured personal-casualty losses (like hurricane damage to your home), which you can deduct only to the extent they exceed 10% of AGI.
• Miscellaneous itemized expenses (usually nonreimbursed employee business expenses and investment expenses), which you can only deduct to the extent they exceed 2% of AGI.
When you have these types of expenses, filing separately can lead to tax-saving results, because the AGI numbers on your separate returns will be lower. Therefore, deductions that are limited by your AGI may be considerably higher when you file separately. Confused? The following example should help:
Example: Say both you and your husband work. Your husband earns less. He also incurred $9,500 of uninsured medical expenses in 2003 (which he paid out of his own pocket), while you had no medical expenses. The federal income-tax results for 2003 if you file jointly vs. using MFS status are as follows:
|File Jointly||File Using
|Adjusted gross income||125,000||55,000||70,000|
|Medical expenses||(9,500)||(9,500)||( — )|
|Add back 7.5% of AGI||9,375||4,125||—|
|Other itemized deductions||(20,000)||(10,000)||(10,000)|
|Combined tax bills||$18,313||$17,002|
Using MFS status rather than filing jointly would save you and your husband a combined $1,311 ($18,313 - $17,002). Not bad! And all it takes to collect this tidy sum is filing two federal returns instead of one (you may have to file two state returns as well).
Note: This analysis looks harder than it is. You can easily figure this out for yourself by playing "what if" games with your tax-preparation software. In fact, being able to do this sort of number crunching is one of the very best things about tax software.
Before You Get Too Excited...
Here's the rub: You and your spouse can't just split your income and deductions up any old way you want in order to maximize your MFS tax savings. The laws of your state determine how you must divide your income and deductions.
The single most important factor is whether you live in one of the community property states (Arizona, California, Idaho, Louisiana, New Mexico, Nevada, Texas, Washington and Wisconsin). If you do, you may be unable to gain much benefit from filing separately. (See below.)
However, if you live in the 41 noncommunity property states or the District of Columbia, you generally report income you earn as well as deductible expenses that you personally pay on your separate return. Ditto for your spouse. (See IRS Publication 17.) For instance, the numbers in the preceding example would be right and proper, as long as Hubby paid all of the medical bills out of his own account and split the other deductible expenses 50/50 with his wife (say by paying them out of a joint account funded equally by both spouses). That being the case, the $1,311 in tax savings is there for the taking. So don't leave that money on the table!
The Dark Side of Filing Separately
Be warned: Using MFS status can disqualify you from a number of potentially valuable tax breaks. For example:
• You can't claim the child and dependent-care tax credit.
• You can't claim the deduction for college tuition and related expenses.
• You can't claim the Hope Scholarship or Lifetime Learning tax credits for higher education expenses.
• You can't claim the college loan interest write-off.
• You can't deduct more than $1,500 of capital losses against ordinary income (compared to $3,000 if you file jointly).
• You can't make a Roth IRA contribution if your AGI exceeds $10,000.
• You can't convert a traditional IRA into a Roth account.
• You must itemize deductions if your spouse itemizes (you can't claim the standard deduction).
This far from an exhaustive list, which is why you should always "run the numbers" with your tax software when evaluating whether MFS status might work for you.
It's Not Too Late!
If you now discover that filing separately would cut your 2003 tax bill, it's not too late — even if you've already filed a joint return for last year. Just substitute two MFS returns for your original joint return. Make sure you get the job done before the April 15 filing deadline. (Sorry, you can't file an amended return switching from joint to MFS status.) This may generate some correspondence with your pals at the IRS, but if the savings are substantial, don't let that stop you.
|If You Live in a Community Property State|
|In the nine community property states, community income is legally required to be split 50/50 between the spouses. Therefore, you must also split community income 50/50 on your separate federal income-tax returns even if you and your spouse use MFS status. Community income generally includes all income from wages and providing services (it doesn't matter which spouse actually earned the income). Community income also generally includes all income from community property assets (those considered owned 50/50 by both spouses under state law).
Deductible expenses paid out of co mmunity property funds must also be split 50/50. Deductible outlays paid out of separate property funds generally must be allocated to the spouse who paid them. (Separate property usually means assets that were acquired with funds from gifts and inheritances that you've kept separate from your community property assets.)
Each spouse must claim his or her own dependency exemption ($3,050 for 2003) on his or her separate return. You and your spouse can allocate exemptions for your dependent children in any fashion you choose. However, you can't split up a child's exemption amount; you either claim the entire $3,050 on your return or nothing. (You and your spouse can't figuratively divide the poor kid in two and then each claim an exemption of $1,525.)
Because the typical outcome for community property state residents is that you must split most or all of your income and most deductions 50/50 with your spouse, there's usually no advantage to be gained by filing separate returns. That's not to say filing separately will never pay off in a community property state. But it's unlikely.