Couples married on the last day of the tax year have two filing status options when filing their tax returns: either married filing jointly (MFJ) or married filing separately (MFS) returns. Here are several issues to consider when filing MFS:
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Couples married on the last day of the tax year have two filing status options when filing their tax returns: either married filing jointly (MFJ) or married filing separately (MFS) returns. Generally, filing MFJ will produce a better tax result. However, other factors—usually personal or financial rather than tax-related—can come into play that cause taxpayers to choose to file MFS returns.
There is one exception to the requirement that married taxpayers file either MFS or MFJ. This is where one spouse lived apart from the other spouse for the last 6 months of the year and (1) pays more than one-half of the cost of maintaining as his or her home, a household (2) which is the principal place of abode for more than one-half the year of a child, stepchild or eligible foster child that (3) the taxpayer may claim as a dependent. (A non-dependent child qualifies only if the taxpayer gave written consent to allow the dependency to the non-custodial parent.) When these requirements are met, the taxpayer can use the head of household status. The other spouse would still file as MFS unless that spouse also qualifies for the exception.
Consequences of Filing Married Separately
Whatever the reason for filing MFS, the consequences encountered when filing separate returns are as follows.
Changing Filing Status
Once a couple files a joint return, the joint filers may not change to filing separate returns after the unextended due date of the tax return. The unextended due date is generally April 15 unless it falls on a weekend or holiday, in which case it will be the next business day.
Liability
When married taxpayers file joint returns, both spouses are responsible for the tax on that return. This means one spouse may be held liable for all the tax due on a return, even if the other spouse earned all the income on that return. This also applies to back taxes and back child support. However, when spouses file MFS, each is liable only for the tax on their own return.
Community Property States
Where taxpayers reside in a community property state, the allocation of income when filing separate returns is governed by state law. If the spouses file separate returns, each spouse, with certain exceptions, must report one-half of the income from community property, and if the couple is estranged or uncooperative, determining the correct amount of income that each should report may be difficult. The IRS can disregard community property laws when a spouse is not informed of community income by the other spouse. However, the IRS’s ability to disregard community property laws only occurs afterward should the IRS question the allocations.
Taxpayers may be able to disregard community property rules if the spouses have an agreement (commonly referred to as a prenuptial agreement, but agreements can also be created after marriage) that their property is separate; thus, income from such property is separate income. An attorney should draft any such agreement.
Following are how some of the most common types of income are treated for federal tax purposes in community property states.
Wages – Earned income from personal service received by a husband and wife domiciled in a community property state is generally community income during the period the community is in existence. Thus, wages are community income during the period of the community and must be split evenly.
Example: Bill and Chris are married and live in a community property state. Bill is employed and had wages for the year of $120,000 ($10,000/month), while Chris is not employed. If they file MFS returns, each will report $60,000 of wages as income. Let’s say they separated on July 1 (i.e., the community ended) but were still married on December 31. They file MFS returns – Bill’s return will include $90,000 of wage income ((6 months x $10,000 x 50%) + (6 months x $10,000 x 100%)) and Chris will report $30,000 of wages (50% of Bill’s $60,000 wages for January through June).
Credit for Tax Withheld on Wages – If a husband and wife domiciled in a community property state file separately for federal tax purposes and each report one-half of the community wages received during the tax year, half the credit for the income tax withheld on the community wages that are reported on separate returns is taken by each spouse.
FICA Wage Withholding – The FICA (Social Security and Medicare) withholding cannot be allocated. It has already been reported to the Social Security Administration and credited under the Social Security Number (SSN) of the individual who actually earned it.
Net earnings from self-employment – Where the net self-employed earnings of a taxpayer is community property, and the spouses file MFS returns, then:
Self-Employment Tax – Is assessed on the taxpayer who actually earned the income. If the spouses jointly operate the trade or business, for SE tax purposes, the gross income and related deductions are allocated between the spouses based on their distributive shares of the gross income and deductions.
Income Tax – For purposes of income tax, the SE income that is community income is divided 50/50 between the spouses. The SE income that is separate income is allocated 100% to the spouse who owns it.
Example: Where a married couple lives in a community property state and only one spouse is self-employed, that spouse must pay SE tax on his total gross SE income, less total business deductions, even though half of the income is attributable to the other spouse for income tax purposes.
Disability and Unemployment Income – Since these are substitutes for current earnings, they are treated as community income.
Dividend & Interest Income – Interest and dividend income can be either separate or community income. This depends on whether the underlying investment that produced the income was acquired with joint or separate funds and whether the couple’s domicile was in a community or separate property state when the investment was acquired.
IRA & SEP Accounts – Traditional IRAs, Roth IRAs, SIMPLE IRAs, and simplified employee pension (SEP) IRAs are separate property by law; thus:
Distributions – Are reported by the individual who owns the IRA.
Contributions – When deductible, the deduction is claimed by the individual who owns the IRA.
Social Security and Equivalent Railroad Retirement Benefits – Are treated as the income of the spouse who receives the benefits.
Pension Income – Income from qualified plan distributions can be either community income or separate income based upon the amount of separate and community income used to fund the pension account. One possible proration scenario is prorating by the respective periods of participation in the pension while married and domiciled in a community property state or a noncommunity property state during the total period of participation in the pension.
Example: Prorating by Years – Suppose Dave has had a 401(k) plan since January 1 of 2010. He and Shirley get married on January 1, 2017. On January 1 of 2020, Dave retires and begins taking distributions from his 401(k) plan. Dave had the 401(k) plan for 10 years, three of which were during his marriage to Shirley. Thus, prorating by year, Dave’s 401(k) distributions would be 70% separate income and 30% community income. If they filed married, but separately, Dave would report 85% of the income (70% plus ½ of 30%), and Shirley would report 15%.
Partnership Income – Income from a partnership is based upon whether:
Income Is Attributable to the Personal Services of Either Spouse – Where the income from the partnership is attributable to the efforts of either s