The “treat me like a child” clause in the Tax Code

While studying some tax law, I came across a curious provision about filing status options on individual tax returns.

One of the key provisions of an individual income tax return (AKA 1040) is what filing status a taxpayer chooses.  Providing for some exceptions for exceptional situations such as abandoned spouses, death, and annulled marriages if you are single on the last day of the tax year you have to file single or head of household and if you’re married you have to file either Married Filing Jointly or Married Filing Separately.

There are a lots of reasons that couples would want to file a joint return.  The most compelling reason is that filing this way almost always results in a lower tax liability.  Which with taxes is the name of the game!

There are some reasons that a couple may want to choose to file separately such as separated tax liability, if one spouse has significant deductions that would result in a global lower tax liability, or if one spouse owes back taxes or student loan payments.

What I found to be super curious is that if one spouse has no gross income, does not file a tax return, and isn’t claimed as a dependent on anyone else’s tax return, then the spouse who does need to file a tax return can actually claim their spouse as a dependent.  It’s kind of like saying “Honey, for government purposes, I am going to treat you like a child. But just for government purposes of course!”  I am not sure that the politicians intended this to be a clause in our tax law that was designed to help or hinder marriages, but alternative interpretations of spousal relations it is an unexpected benefit or reading tax law.

Following is a more thorough list of the pros and cons of the two main filing status available to married couples.

What You Lose By Filing Separately

Filing separately can disqualify or limit your use of potentially valuable tax breaks, including (but not limited to):

  • The child and dependent care tax credit
  • The adoption credit
  • The Earned Income Credit
  • Tax-free exclusion of U.S. bond interest
  • Tax-free exclusion of Social Security benefits
  • The credit for the elderly and disabled
  • The deduction for college tuition expenses
  • The student loan interest deduction
  • The American Opportunity Credit and Lifetime Learning Credit for higher education expenses
  • The deduction of net capital losses
  • Traditional IRA deductions
  • Roth IRA contributions

What You Gain By Filing Separately

Separation of Your Tax Liability From Your Spouse’s

It may be preferable to file separately when you need to separate your tax liability from your spouse’s. Signing a joint tax return makes you both responsible for the accuracy and completeness of the return and obligates you for any current or future tax liability or penalties. If you file separately, you will only be responsible for the accuracy and payment of taxes for your own return.

Lower Overall Tax Bill If One Spouse Has a Significant Itemized Deduction

If you and/or your spouse both have taxable income and at least one of you (ideally the person with the lower income) has significant itemized deductions that are limited by adjusted gross income (AGI), you should run the numbers to calculate the potential advantages of filing separately.

Common itemized deductions limited by AGI are:

  • Medical expenses, deductible only to the extent they exceed 10% of AGI—7.5% if you’re age 65 or older
  • Personal casualty losses, deductible only to the extent they exceed 10% of AGI
  • Miscellaneous itemized expenses, such as un-reimbursed employee business expenses, fees for tax advice and preparation, and investment expenses, deductible only to the extent they exceed 2% of AGI
  • Charitable contributions, deductible up to 20%, 30%, or 50% of AGI, depending on the type of gift

For example, AGI determines if a couple can deduct un-reimbursed healthcare costs and casualty losses on Schedule A. However, out-of-pocket medical expenses must exceed 10% of AGI to qualify as a deduction. Casualty losses must also total more than 10% of AGI. (See IRS guidelines on medical deductions.)

The spouse with the substantial medical expenses calculates deductibility against only his lower AGI when filing separate returns. As each spouse’s AGI—and AGI limits—are lower on separate returns, allowable deductions for these types of expenses may be considerably higher if you file separately. When one spouse can lower taxable income this way, married filing separately might reduce a couple’s overall tax liability.

State Considerations

State income taxes can also impact your decision. In some states, considering the total federal and state tax liability together may change the numbers in favor of filing separately.  When one or both spouses live in a community property state, special rules apply for allocating income and deductions between each spouse’s tax return. Each spouse generally reports half of the total income and half of the deductions on each tax return. Community property states are: Arizona, California, Idaho, Louisiana, New Mexico, Nevada, Texas, Washington, and Wisconsin.

The bottom line is that it’s important to do the math both ways—filing separately and jointly— to see which provides the overall lowest tax liability.

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List compiled by: Lisa Hay from betterment.com