As you read this edition, I’m officiating the wedding of two friends who are members of our tax professional community. To celebrate this occasion, I’m dedicating this edition to the married filing joint tax filing status.
When a tax professional gets a new client who is married, we often automatically default to filing a joint return. As most of us know, there are many disadvantages in the Internal Revenue Code to filing separate returns, such as compressed tax brackets and reduced/eliminated deductions and credits.
In some unusual situations, separate returns may actually provide for an overall lower net tax than joint returns. For example, on tax year 2020 returns, the structure of several one-time tax benefits — the unemployment exclusion and the first two recovery rebate credits — sometimes led to separate returns creating thousands of dollars in net tax savings. In tax year 2021, there may be similar situations due to the enhanced child tax credit and the third recovery rebate credit.
Tax professionals usually file a tax return with the legally permitted filing status that provides for the lowest overall net tax; however, there are some situations when a lower tax joint return may not be optimal as a joint return creates joint and several liability for both spouses for that tax return. Here are three scenarios where this may be the case:
One spouse has tax-related problems: poor business records, inappropriate tax return positions, unreported income, or unpaid debts for which a refund would be offset. By filing a joint return, the problems of the one spouse can attach to the other spouse, or the entire joint refund can be fully offset to the one spouse’s unpaid debts. Injured spouse relief requested on Form 8379 may mitigate some or all of the refund offset issue, thus making the joint return the better option.
If one spouse has a large balance due, and the other spouse has a refund or small balance due, the filing of a joint return makes the one spouse liable for the large tax debt of the other spouse. If the non-liable spouse gives informed consent, and they plan to full pay the balance, then this may be acceptable to both parties. If they do not have the ability to full pay the balance, then filing a joint return makes the non-liable spouse’s income and assets subject to IRS collection.
If a U.S. citizen or resident marries a nonresident alien, §6013(g) allows the nonresident alien to elect to be treated as a U.S. resident for federal tax purposes to allow the filing of a joint U.S. tax return with the U.S. person. This is often done by taxpayers and tax professionals with no consideration of the downstream consequences of this choice. This election makes the foreign spouse’s worldwide income subject to U.S. tax when it would otherwise not be. It also makes the foreign spouse’s assets subject to the complex foreign asset reporting requirements in the U.S. The foreign spouse may also have foreign assets with complex U.S. tax treatment (i.e. pensions, insurance policies, mutual funds, and corporate stock) that would dramatically complicate future U.S. tax return preparation.
Once a taxpayer files a joint return, the filing status cannot be changed unless the taxpayer files a superseding return on or before the unextended Form 1040 deadline, as we discussed in a prior edition of this newsletter.
On the other hand, if a taxpayer files a separate return, §6013(b)(2) allows the taxpayer to make a joint election no later than three years after the unextended due date of the tax return. For example, a taxpayer who filed a separate 2018 Form 1040 has until April 15, 2022 to file Form 1040X to change to a joint return with his or her spouse.
For taxpayers subject to community property law, separate returns are more complex than a joint return as each spouse must generally report 50% of all community income. However, there may exceptions to this general rule, such as a pre-nuptial or post-nuptial agreement electing out of community property treatment, or the marital community never arises under state law due to how the spouses arrange their financial lives. These are state law issues that require consultation with a qualified attorney.
Every client has a unique tax situation that easily changes from year-to-year. Because of this, tax professionals should review each year whether or not the joint filing status is optimal for married clients. For taxpayers who decide to file separate returns, they have several years to decide if they want to change to a joint return if the situation that caused them to file separate returns is no longer applicable.
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