When it comes time to file your taxes, your filing status is a crucial choice that affects whether you need to file a return, your standard deduction, and the amount of tax you owe. Your filing status also determines eligibility for certain deductions and credits. There are five primary filing statuses to choose from:

  • Single: unmarried, divorced, or legally separated
  • Married Filing Jointly: married or if you spouse passed away during the year
  • Married Filing Separately: married, but choose to file separately
  • Head of Household: single and you pay more than half of the living expenses for yourself and a qualifying dependent
  • Qualifying Surviving Spouse: your spouse passed away during the past 2 years and you have a dependent child

If more than one filing status applies to you, it’s beneficial to choose the one that results in the lowest tax liability.

Marital Status and Its Impact on Filing

Your filing status largely depends on whether you are considered unmarried or married at the end of the tax year. You are seen as unmarried if you are single, divorced, or legally separated under a divorce or separate maintenance decree by December 31st.

Changes in Status

If you are married by the last day of the tax year (12/31), you are considered married for the entire year.  You may no longer use the “single” filing status and must decide to file as Married Filing Jointly or Married Filing Separately.

If you are divorced by the last day of the tax year, you are treated as unmarried for the entire year.

Deciding Between Joint or Separate Returns for Married Couples

“MFJ” (Married Filing Jointly) and “MFS” (Married Filing Separately) are two different tax filing statuses available to married couples in the United States.

Generally, married couples choose MFJ for its more favorable tax treatment, but MFS might be chosen for various reasons, such as when one spouse has significant medical expenses, miscellaneous deductions, or when there’s a need to separate tax liabilities among spouses. Filing separately might be advantageous if you wish to be responsible only for your own tax or if there are significant differences in income or deductions between spouses. However, it often results in a higher tax bill compared to filing jointly!

Here’s a comparative table outlining the differences between the tax implications for couples filing Married Filing Jointly (MFJ) and Married Filing Separately (MFS):

 

AspectMarried Filing Jointly (MFJ)Married Filing Separately (MFS)
Tax Rates and BracketsBenefit from lower tax rates and more favorable tax brackets.Higher tax rates and less favorable brackets.
Tax Deductions and CreditsQualify for more tax deductions and credits.Reduced eligibility for deductions and credits like the EITC.
Standard DeductionDouble that of single filers, more beneficial overall.Halved for each spouse, generally less beneficial.
LiabilityJoint and several liability for taxes, penalties, and interest.Each spouse is responsible only for their own tax liabilities.
Requirement for ConsistencyNot applicable; deductions are jointly claimed.If one spouse itemizes, the other must also itemize.
Eligibility for Other Tax BenefitsGenerally, no restrictions, unless over income limits.Eligibility for benefits like child care credits may be limited or unavailable.

 

Filing MFS in a Community Property State

When filing as Married Filing Separately (MFS) in a community property state, there are specific guidelines that must be followed due to the community property laws. These states include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.

In community property states, each spouse or registered domestic partner (RDP) must report half of the combined community income on their separate tax returns. This includes not just earnings from employment but also other forms of income such as dividends from shared investments or income from community property businesses. Each person also reports their separate income entirely on their own return.

The division of deductions is also governed by community property rules. Expenses that are used to generate community income should be split equally between the spouses. This means if one spouse has business expenses, they can only claim half of those expenses on their separate return, assuming the income from the business is considered community income.

Here’s a simplified table illustrating how income and expenses are typically reported on tax returns for each spouse when filing as Married Filing Separately (MFS) in community property states:

CategorySpouse ASpouse B
Community Income (ex. W2, Self employed income, joint investment accounts)Report 50% of total community incomeReport 50% of total community income
Separate IncomeReport 100% of own separate incomeReport 100% of own separate income
Community Expenses (including itemized deductions,  tax withholdings, etc.)Deduct 50% of expenses used to generate community incomeDeduct 50% of expenses used to generate community income
Separate ExpensesDeduct 100% of expenses incurred to generate separate income on separate returnDeduct 100% of expenses incurred to generate separate income on separate return

 

Explanation:

  • Community Income: salaries, wages, and income from joint ventures or properties earned during the marriage or income from property acquired during your marriage. 
  • Separate Income: Any income that is not derived from community property or effort, such as income earned from separate property or after separation. This could also include community property that has been converted or treated as separate property through a valid agreement under state law.
  • Community Expenses: Expenses related to generating community income should be divided equally. For instance, if there’s an investment property generating income, any related expenses would be split or expenses related to self-employment income that is considered community property.
  • Separate Expenses: If one spouse incurs expenses to generate their separate income, only that spouse can claim the deduction on their tax return.

This specific way of splitting income and deductions can lead to different tax implications compared to non-community property states. For example, even though each partner reports only half of the community income, they must also adhere to state-specific rules which might complicate the preparation of their tax returns. In some cases, such as with itemized deductions, if one spouse itemizes, the other must do so as well, which can be unfavorable if the other spouse would have benefited more from the standard deduction.

Moreover, certain federal tax benefits might not be fully available when filing MFS in a community property state, such as the Earned Income Tax Credit (EITC), education credits (American Opportunity Credit and Lifetime Learning Credit),  and child and dependent care credits, which are generally reduced or unavailable for MFS filers.  Capital loss deduction is also limited to $1,500 instead of the standard $3,000.

Conclusion

This general guideline helps in understanding the division and reporting of income and expenses for MFS filers in community property states. However, specific situations can vary. For more detailed guidance, it’s advisable to refer to IRS Publication 555 on community property or consult with a tax professional familiar with both federal and your resident state’s tax laws.

 

Aura Advisors is a boutique tax consulting and compliance firm working with start-ups, emerging growth companies, and affluent individuals. Making it safer for good people and good companies to continue to do good things.