If you're happily married, conventional wisdom says you should always file a joint federal income tax return with your spouse. However, there are exceptions. Here's the story, starting with the basics.
Married at Yearend Equals Married All Year
Your marital status for federal income tax purposes generally depends on whether you were married as of Dec. 31 of the year in question. For example, say you got married near the end of 2011. As far as the Internal Revenue Service is concerned, you were married for all of last year. So your 2011 tax filing options are limited to: (1) filing jointly with your spouse by combining your income and deductions on one return for the entire year or (2) using married filing separate (MFS) status, which requires you and your spouse to file independently showing your separate income and deductions for the entire year on your respective returns.
Why Not File Jointly?
Filing jointly will surely reduce the combined tax hit on you and your spouse. Right? Not necessarily. In many cases, the biggest reason to file jointly is because it eliminates the need to file two returns. In other words, joint filing is simply more convenient. You may not save a dime in taxes.
That said, filing jointly usually does lower your tax bill when one spouse earns a healthy amount of income while the other earns quite a bit less or nothing. The reason? The joint-filer tax brackets are exactly twice as wide as the MFS brackets. So when one spouse earns quite a bit and the other not so much, filing jointly will usually cut your tax bill because more of the higher-earning spouse's income gets taxed at lower rates. In this situation, the conventional wisdom is correct, and filing a joint return is the tax-smart option. Still, you should not reflexively reject the MFS option. It can save taxes in certain circumstances that could apply to you. Please keep reading.
When and How to File Separately
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 and so forth) reduced by non-itemized write-offs claimed on Page 1 of Form 1040 (retirement account contributions, alimony paid, job-related moving expenses, and so on). When you use MFS status, you separately calculate your AGI and your spouse's AGI, and this can work to your advantage.
The three most common itemized write-offs that are limited by r AGI are:
* Medical expenses (deductible only to the extent they exceed 7.5% of AGI).
* Personal casualty losses (deductible only to the extent they exceed 10% of AGI).
* Miscellaneous itemized expenses such as unreimbursed employee business expenses, fees for tax advice and preparation, and investment expenses (deductible only 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, your allowable deductions for these types of expenses may be considerably higher if you file separately. Here's an example.
You and your husband both work. Your husband earns less. He also incurred $10,000 of uninsured medical expenses in 2011 (which he paid out of his own resources), while you had no medical expenses. Here are the federal income tax results for 2011 if you file jointly versus using MFS status.
|File Jointly||File Using
|Adjusted gross income||135,000||55,000||80,000|
|7.5% of AGI||10,125||4,125||none|
|Medical expense deduction||none||5,875||none|
|Other itemized deductions||(20,000)||(10,000)||(10,000)|
|Combined tax bill||19,150||17,681||17,681|
Using MFS status would save you and your spouse a combined $1,469 ($19,150 - $17,681), and all it takes to collect this benefit is filing separate federal returns (you may have to file separate state returns too).
Before You Get Your Hopes Up...
Here's the rub: you and your spouse cannot just split your income and deductions up any way you want in order to maximize the MFS tax savings. Instead, state law determines how you must divide up your income and deductions.
The single most important factor is whether you live in one of the nine 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 because you will probably have to split most or all of your income and deductions 50/50. (See the sidebar below.)
If you live in one of the 41 non-community property states or the District of Columbia, the general rule is that you and your spouse can each report the income you earn and the deductible expenses you pay on separate returns. (See IRS Publication 17 at www.irs.gov.) For instance, the tax savings in the preceding example can be collected as long as the husband paid all 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).
Beware Of Dark Side of Filing Separately
Beware: using MFS status can disqualify you from a number of potentially valuable tax breaks. For instance, the following tax goodies are off limits.
* The child and dependent care tax credit.
* The deduction for college tuition expenses.
* The American Opportunity and Lifetime Learning tax credits for higher education expenses.
* The college loan interest write-off.
* The deduction for up to $3,000 of net capital losses (the deduction is limited to only $1,500 on a separate return).
* The right to make a Roth IRA contribution if your separate AGI exceeds $10,000.
This is not a complete list. You should always "run the numbers" with your tax preparation software when evaluating whether MFS status might work for you.
If You Live In a Community Property State
In the nine community property states, state law requires community income to be split 50/50 between the spouses. Therefore, you and your spouse must split community income down the middle if you use MFS status. Community income generally includes all income from wages and providing services (it doesn't matter which spouse actually earns the income). Community income also generally includes all income from community property assets (those assets that are considered owned 50/50 under state law).
Deductible expenses paid out of community property funds must also be split 50/50 if you use MFS status. Deductible outlays paid out of separate property funds generally must be allocated to the spouse who paid them. (Separate property usually means assets acquired with funds from gifts and inheritances that you've kept separate from community property assets.)
If you use MFS status, each spouse can claim his or her own personal exemption ($3,700 for 2011) on his or her separate return. You can allocate exemption deductions for your dependent kids ($3,700 each for 2011) any way you want.
Because the typical outcome for community property state residents is that most or all income and deductions must be split 50/50, there is usually no tax-saving advantage from filing separate returns. Using MFS status is only beneficial when you're allowed to split income and deductions unequally, as illustrated in the example.