File Jointly or Separately?

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The first tax question confronting any newly married couple is your filing status. You have two choices:

• Married filing separately
• Married filing jointly

There are pros and cons for each. Couples who are married and filing jointly, for instance, may enjoy lower tax rates on their combined income. Married filing jointly also makes each of you responsible for the accuracy of the return: both spouses must sign. Generally speaking, there are more tax benefits to filing jointly, but there may reasons to file separately.

If one spouse is self-employed and the other doesn’t want to be connected to the business, filing separately may be an option. Filing separately might also make sense if one spouse owes income taxes and it would threaten the other spouse’s refund to file jointly.

Potentially Lower Income Taxes

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We noted above that married couples filing jointly qualify for lower combined income tax rates than couples filing separately. This is especially attractive to couples with differing levels of income. But this is not the only way marriage can impact the size of your IRS bill. A number of tax credits may only be claimed by couples who file jointly, including:

• Adoption Expense Credit
• Lifetime Learning Credit

Another consequence to consider is that if you are married and filing separately – and one spouse itemizes their deductions – the other spouse gets a standard deduction of $0. This essentially forces the other spouse to itemize (whether they originally found this to be desirable or not) to avoid losing tax deductions altogether.

No Estate Tax

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One of the most powerful tax benefits available to married couples is the unlimited marital deduction. As SmartMoney explains:

“If your spouse is a U.S. citizen, you can leave any amount to him or her with no federal estate tax hit. If you are a U.S. citizen, your spouse can do the same. This is the so-called unlimited marital deduction privilege. For married couples, the $5 million federal estate tax exemption and the unlimited marital deduction privilege provide significant federal estate tax shelter for those who die in 2011 or 2012.”

Don’t ignore this. A freshly married couple in their mid-20′s might not be thinking about estate planning (it’d be a little weird if they were) but as the years pass, it will increasingly loom large in their future decision making.

Exempt From Gift Taxes

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Married couples also get more bang for their buck when it comes to the gift tax exclusion. Currently, there is an annual federal gift tax exclusion of $13,000 for 2011 (meaning your recipient can “”immediately and without restriction use, possess, or enjoy the gifted property” without tax consequence to you.) As a married couple, you get to combine this exclusion. SmartMoney offers the following potential scenario:

“With two adult children and four grandchildren, for example, you and your spouse could each give them $13,000 each in 2011 for a total of $156,000 (6 x $13,000 x 2). Then, do the same thing in 2012. Over the two years, your taxable estates would be reduced by $312,000 (2 x $156,000) with no adverse federal gift or estate tax effects.”

As your wealth grows, be mindful of ways to use the gift tax exclusion to strategically transfer assets to loved ones (or between each other.)

Child Tax Credit

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No tax benefit is more appealing to child-rearing couples than the Child Tax Credit. This credit, the IRS says, enables couples to reduce their taxable income by as much as $1,000 per every “qualifying child” they have. Six criteria decide whether your child qualifies: age, relationship, support, dependent, citizenship, and residence. The child must be under 17, not have provided “more than half” their own support, must be related to you (by blood, marriage, or adoption), a U.S. citizen, claimed as a dependent on your tax return, and live with you for over half the year.

When trying to decide how to file, don’t worry.  TurboTax can help you figure out whether file married filing jointly or married filing separately.

A new status often means new tax implications (and strategies).

Take a look:

Did you Change your Status to Single?

While breaking up with a boyfriend/girlfriend is easy relative to going through divorce, annulment, or legal separation (Just donate his/her stuff to charity and call it a day!), don’t make the situation worse by ignoring important tax considerations. Among them: property settlements, alimony (It’s fully taxable as income to the recipient and provides an “above the line” deduction for the payer); and kids. Who get the tax benefits and exemptions as it pertains to them? Generally, the custodial parent does, but check your divorce decree to see if it specifies otherwise. As for filing status, many divorced people file as Single. However, if you are divorced and at least one of your kids lives with you, you are a custodial parent and will most likely be able to file as Head of Household. That’s a good thing – HOH status generally results in a much lower tax bill. Separated?  You can file as Married Filing Separately or Married Filing Jointly, but filing jointly is typically the most beneficial status (see below).

Did you Change your Status to Married?

If you exchanged “I Do’s” anytime in 2010–even if you got married just seconds before the ball dropped on New Year’s Eve–you will be considered legally married for the full tax year. One of the first things you need to do – in addition to contacting the Social Security Administration if you changed your name – is change your filing status.  You can either file as married filing jointly or married filing separately.  In some situations, you can even file as head of household, but you cannot file as single. What’s typically the best way to go? Married filing jointly.  It provides the lowest tax liability and the highest standard deduction. Yes, there are some situations where it might be advantageous to file separately – for example, if one taxpayer has high medical expenses and very little income, or if you suspect your spouse is involved in fraudulent behavior – know that when you file separately you lose valuable credits and deductions, from education benefits to student loan interest deductions and more.

Did you change your status to Engaged?

As you prepare for this next chapter in your life, don’t let the excitement and joy of it all prevent you from having a conversation about your financial future. Before you walk down the aisle, know where your soon-to-be spouse would like to be in 5, 10 years, what assets/liabilities they have (Does he/she owe back taxes? Child support from a former marriage? Has he/she defaulted on student loans?), how you’re going to tackle any existing debt, whether you’re going to keep your finances and investments separate or combine them, how you will handle daily spending decisions, and who will be responsible for paying the bills and preparing the taxes. At this time, you’ll also need to think about changing your withholding.

Did you change your status to In a Relationship?

Not all those in a relationship cohabitate, but for those who do, there are some tax implications.  No doubt, there are more couples living together these days–7.5 million opposite-sex couples in 2010, according to the US Census Bureau. That’s 13% more than in 2009. While some heterosexual couples living together can enjoy the rights of marriage without getting hitched the traditional way by claiming common law marriage (recognized by law in over a dozen states), most unmarried couples—especially same sex couples–are up against numerous financial hurdles compared with their married peers. From who gets the homebuyer credit to who claims the kids to health insurance coverage (The IRS doesn’t recognize domestic partners–That means benefits provided for your partner are treated as taxable income) to how you should structure purchases to maximize tax advantages, there are many issues to consider.

Did you change your status to It’s Complicated?

I’ll be honest… I’m not entirely sure what “It’s Complicated” means! If you changed your status to this option in 2010, chances are your taxes are the least of your worries.

If you suspect your spouse is cheating on his taxes, under-reporting income or over-reporting tax deductions, by filing separately, you will be liable only for the taxes on your own return if the IRS audits and determines additional taxes are due. If you did file a joint tax return, you still have some protection, since you could claim innocent spouse status, but you might have to show that you didn’t know about your spouse’s schemes to save taxes.

If your marriage is on the rocks, you and your spouse may not agree about how tax refunds should be shared or who should pay any additional taxes due. Filing separate tax returns can resolve that dispute, with each spouse liable for the taxes on their own return.

If you are living in a community property state (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington or Wisconsin). filing separately might not be beneficial. In community property states, most income and expenses must be combined and reported half on each tax return. That complicates tax return preparation and requires coordination and sharing tax information. And if errors later are uncovered by the IRS, innocent spouse rules won’t help you, since they only apply to joint returns. See IRS Publication 555, Community Property, for more information.

Married filing separately has other drawbacks and limitations. If one spouse itemizes tax deductions, so must the other spouse, even if she would be better off claiming the standard tax deduction. Forget taking special tax deductions and credits, such as interest on student loans, child and dependent care tax credit, earned income tax credit, exclusions for savings bond income used for education, education credits, credit for adoption expenses, and credit for the elderly or disabled. None of these are allowable on separate returns. People who are married filing separately will pay tax on more of their Social Security benefits, can’t do an IRA rollover, and can claim only half the capital losses they could on a joint return.

If you are in doubt about your best filing option, tax preparation software like TurboTax will figure your taxes as both joint and separate filers and use the method that produces the lower tax bill. Chances are that married filing jointly will be your best choice. Read more about filing status in this FAQ.

1. Time your marriage to minimize taxes. If both you and your beloved are employed, you might pay more taxes as a married couple, so it might be better to marry the following January than December. But if one of you earns most of the money, you might pay less, so a December wedding might be wise. You can use tax software like TurboTax to project your tax liabilities to help you decide.

2. File joint income tax returns (in most cases). Married couples filing separately are barred from many deductions and credits. File separately if your attorney advises you to keep your income separate to clarify child support or alimony issues.

3. Review your retirement plan contributions. If you weren’t able to contribute the max to your retirement plans when you were single, combining forces with your honey may finally allow you the financial flexibility to up your contributions, which will lower your taxes.

4. Change your withholding status. File a new W-4 with your employer to revise your withholding status from single to married, so that you aren’t surprised with extra taxes at year end.

5. Donate extra household goods by year end. When combining households, you may have ended up multiple small appliances and housewares. As you pare down to make room for everything, box up your exceed household goods and donate them to charity. Make a list before you do, so you can use It’s Deductible for free to calculate the value of your donated items, and store the information for tax time.

6. Notify the Social Security Administration if you changed your name. If you’ve changed your name or adopted a hyphenated name, report your name change to the Social Security Administration. Go to www.ssa.gov and download form SS-5. Take the form, plus your marriage certificate and your driver’s license or passport, to the SSA office. Do it now to you’ll avoid any potential matching problems when you file your next tax return.

7. If you bought a new home, deduct the points. Points paid when you acquire your home are deductible in that year. Points paid to refinance a loan must be written off over the length of the loan. If you refinance in the future, don’t forget to write off the remaining unamortized points in the year you refinance.