The Pros and Cons of Filing Separate Tax Returns

By Foss, Helga B. | The National Public Accountant, November 1994 | Go to article overview

The Pros and Cons of Filing Separate Tax Returns


Foss, Helga B., The National Public Accountant


WHILE MOST COUPLES AUTOMATICALLY FILE JOINT FEDERAL AND STATE INCOME TAX RETURNS, SEPARATE RETURNS MAY ACTUALLY BE MORE ADVANTAGEOUS UNDER CERTAIN CONDITIONS. THERE ARE, HOWEVER, CERTAIN SITUATIONS IN WHICH SEPARATE RETURNS SHOULD BE CONSIDERED.

Tax rates for separate returns are constructed to equal the tax liability on a joint return. Theoretically, this should guarantee that couples who file separate returns pay the same tax liability as those who file jointly. In fact, under the tax rate schedules that applied prior to 1988, married couples earning unequal amounts of income were almost always better off filing a joint return. Because of the graduated rate structure, income on the separate return of the higher earner would be pushed into a higher income tax bracket than on a joint return. This effect almost always wiped out any other benefit from filing separately.

Advantages of Filing Separately

Advantage Due to AGI Floor

If married taxpayers itemize their deductions, expenses that might be lost on a joint return may be deductible on separate returns. Since medical expenses, casualty losses, employee business expenses and certain other miscellaneous expenses are subject to various percentage limitations, taxpayers will benefit from separate returns if these expenses are paid by the spouse with the lower earnings.

Separate State Returns

If the state tax rate schedules are the same whether a joint or a separate return is filed, a joint return will only shift one spouse's income into a higher tax bracket. Therefore, separate state returns are advantageous but may require separate Federal returns as well. Of course, this is only beneficial as long as any increase in Federal liability is more than offset by the decrease in state tax liability.

IRA Contribution

If one spouse earns less than $10,000, a portion of his or her contribution to an IRA will be deductible regardless of how much income the other spouse earns and whether or not there exists coverage through a pension plan.

On a separate return the IRA phaseout takes place for a modified AGI between $0 - $10,000. For example, Jack earned $46,000 and Jill $4,000, and Jack is covered by a pension plan at work (assuming total earnings equal modified AGI). On a joint return the deduction is completely phased out when modified AGI reaches $50,000; therefore, neither Jack nor Jill can deduct a contribution to an IRA. However, on separate returns Jill may deduct a payment of $1,200 to her IRA ($2,000 less 4,000/10,000 x 2,000).

Disadvantages of Filing Separately

A number of items are only available on joint returns (unless the taxpayers can be considered single):

* The child and dependent care credit generally requires a joint return.

* Married taxpayers' social security income becomes taxable above a base amount of $32,000 of AGI plus tax-exempt interest, plus one half of social security benefits, the "provisional income." The base amount of married taxpayers filing separate returns is $0 unless they live apart for the entire tax year. Therefore, the lesser of 85% of social security benefits or 85% of the provisional income would be included in gross income if married taxpayers file separate returns.

* Passive activity losses from rental real estate are deductible up to $25,000 for modified AGI of $100,000 or less if the taxpayer actively participates in management and owns at least a 10% interest. The deduction is phased out between $100,000 and $150,000. However, no deduction is available on a separate return unless the spouses live apart. In that case, $12,500 is available with corresponding reductions above AGI of $50,000.

* If one spouse incurred capital gains while the other had capital losses, the opportunity to offset gains with losses is lost. Capital losses on a separate return are limited to $1,500 instead of $3,000 on a joint return.

* While a separate return was advantageous for a contribution to the IRA of the spouse who earned less than $10,000, a separate return would preclude a deductible IRA contribution if each spouse earns more than $10,000 with total AGI below $50,000. …

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