An area that needs to be examined while you are going through the divorce process is determining the tax filing status that will be the most advantageous to you. During the pre-divorce year(s), you have a couple of options that can increase or reduce your tax liability depending on which filing status you utilize. In your pre-divorce year(s), you have the option of filing under the following statuses:
- Married Filing Jointly (MFJ),
- Married Filing Separate (MFS), or
- Head of Household (HOH)
Once the divorce has been finalized or you have been legally separated in certain states, you will have the option of filing under the following statuses (unless re-married):
- Head of Household (HOH)
- Single (S)
The marital status for the tax year is determined by your marital status on December 31st of the current year. Your marital status is determined by state law. If you have not received your divorce decree or are not under a decree of separate maintenance by December 31 of the current year, you are considered married for federal income taxes purposes. In that case you and your spouse have the option to use the married filing joint status. You will combine your income, expenses, and taxes on one return. Both you and your spouse must sign the return and once you file a joint return, you can’t amend the return and change the status to married filing separate.
Disadvantages to Electing the Married Filing Joint Status
Before you consent to filing a joint return with your spouse, it is important to understand the following disadvantages:
- Joint and several tax liability – when a joint return is filed, you and your spouse are jointly and severally liable for any understated income taxes or unpaid taxes for the year filed. What this means is that the Internal Revenue Service can go after either spouse for 100% of the tax owed regardless of the party who under-reported income or over-reported deductions for the year a joint return was filed.
- Marriage tax penalty – for higher income earning joint filers, the marriage tax penalty still comes into play and can increase your overall federal income tax over different tax filing statuses. Changes to the tax code in 2003 with extensions filed in 2004 to continue through 2010 provided relief to married taxpayers, thus making the marriage tax penalty less of an issue for taxpayers in the 10% and 15% brackets.
Advantages to Electing the Married Filing Joint Status
In most instances, if you elect to file a joint return with your spouse, you and your spouse will typically pay less in combined taxes than you would if you had filed separate returns. There are several tax related items you are entitled to if you meet specific requirements. Tax deductions and credits eligible if married filing jointly but not married filing separately include the following:
- The joint tax brackets are higher and can result in lower taxes.
- You would have the ability to claim the following related child deductions or credits (if qualified):
- The student loan interest deduction
- The tuition and fees deduction
- The child and dependent care expenses tax credit (in most cases)
- The higher education tax credits (Hope and Lifetime Learning credits)
- You would be eligible to take advantage of the earned income credit (EIC). If you are a taxpayer in a lower income tax bracket and can qualify for this tax break, having the ability to take this deduction can reduce your taxes significantly.
- If you have a capital loss carryover from prior periods, you will be able to deduct the maximum amount of the $3,000 instead of half or $1,500 as a deduction if married filing separately.
- You will be able to make a Roth IRA contribution depending on your adjusted gross income.
- You would be able to convert a traditional IRA into a Roth IRA account if you do not exceed certain income limitations
As you can see, the tax advantages of the married filing joint status should be considered - especially if you earn significantly more income than your spouse. The tax brackets for the married filing joint status are more favorable than the filer using the married filing separate status. You will need to obtain your spouse’s consent to file jointly. If you can work together and trust that your spouse is accurately reporting his/her tax related items, using the married filing joint status can save tax and leave more money to split when the divorce is final.
If you file married filing jointly you should include a tax liability indemnification clause in your divorce language to provide some legal recourse in the event of later tax related issues.
We will cover the advantages and disadvantages of other tax filing statuses in future articles. Married filing jointly is one option to consider. Married filing separate, Head of Household, and the Single statuses should be considered as part of your divorce financial plan.
If it is likely that the divorce will be final before year-end, you will want to review different tax strategies to see if it would be beneficial to finalize the divorce in the current year, or postpone the divorce until the next year. We recommend that you review your financial situation with your qualified tax advisor to help in determining the best strategy for you. Each situation is different and changing the fact pattern for each scenario can have a material impact on determining which financial strategy would be best for you.
