As you and your spouse prepared to walk down the aisle, chances are you were daydreaming about that beautiful day to profess your love to the world, that search for your first home together, and even starting a family. The honeymoon often ends, though, when it comes to money – what are you going to do with your taxes?
For most married couples, the difference between filing separately or jointly is considerable and the decision is consequential. As we’re coming up on Valentine’s Day and in the heart of the 2017 tax season, let’s discuss this season’s most pertinent question: How will you and your spouse file your taxes?
Let’s look at some examples, and for illustrative purposes, we’ll assume that no deductions are taken.
Married and Filing Jointly vs. Married and Filing Separately
Kristy is a teacher who makes $35,000 per year. Her husband Steven owns a business, and he makes $200,000 per year. Kristy is in the 15% tax bracket, so she owes $4,786 in taxes. Steven is in the 33% tax bracket and owes $53,707 in taxes. If they file their taxes as married individuals filing separately, the total combined they owe in taxes is $58,493.
However, if they file as married individuals filing jointly, they are in the 33% tax bracket and will end up owing $52,963. They earn a “bonus” of $5,530 by filing jointly.
Jeremy is an engineer and makes $120,000 per year. His husband Terrell is in sales and makes $130,000 per year. They are both in the 33% tax bracket, so Jeremy owes $27,307 and Terrell owes $30,607 in taxes. Together, they owe $57,913 if they were to file separately. However, if they filed jointly, then they would owe $57,913 as well.
Tax Credits and Tax Deductions
Other variables to consider in this equation are tax credits and tax deductions. Tax credits are dollar-for-dollar reductions on tax bills. Tax deductions are a reduction in taxable income contingent on tax brackets. Credits and deductions lower net tax bills.
Some of these include, but aren’t limited to:
- Child and Dependent Care
- Earned Income Tax Credits
- Education Credits
- American Opportunity
- Lifetime Learning Education Credits
Keep in mind that filing jointly affords tax credits that may not apply if married couples file separately. In addition, joint filers must meet higher income thresholds for some tax credits and deductions. While they can earn more in combined household income before paying higher rates, they must earn more to qualify for certain tax credit and deductions.
Potential Tax Risks
Filing jointly poses its own risks if one spouse has tax issues, such as owing the IRS money. If a spouse has a tax lien or is in debt to Uncle Sam, their new spouse may assume the responsibility of these burdens if they file jointly. If such couples file separately, the tax liens and government debt remain the sole responsibility of the original spouse. As such, filing separately could shield certain assets from the government.
Filing separately reduces deductions such as those mentioned previously, in addition to deductions such as those for traditional Individual Retirement Account. While it’s good to invest in an IRA regardless, filing separately reduces immediate benefits. One of you may qualify to contribute the maximum to a Roth IRA if you file separately, whereas filing jointly neither of you may qualify.
Adjusted Gross Income (AGI) is the total of all income minus specific deductions. Deductions that require a percentage of AGI are easier to meet by filing separately rather than jointly. Such deductions include but aren’t limited to:
- Alimony deduction
- Miscellaneous expenses greater than 2% of your AGI
- Emergencies greater than 10% of your AGI
This may all sound terribly confusing. No matter how much you learn about taxes here and elsewhere, it’s best to work with a tax professional. The IRS and certain companies offer ways to file taxes for free, but it’s worth your time to speak with a tax professional to get all your tax questions answered.
Whether you and your spouse choose to file your taxes jointly or separately, filing properly may help you more quickly achieve that happily-ever-after you daydreamed about together.