I recently wrote about the phenomenon of married taxpayers filing separately to avoid the phasing out of clawback and child credits. I picked up the story by following #TaxTwitter, where the tax pros go to sympathize. My sources in the tax press confirmed my impression that this story didn’t get much attention beyond the action on Twitter. Most disturbing was an unscientific investigation I did.
I will say that there are quite complicated calculations. Complicated enough that I won’t try to explain them in detail. But it’s not a rocket ship operation and the reports I’ve received indicate that most software will split returns, although there will likely be some sort of futzing required beyond pressing a button.
Who is it for ?
Robin and Terry have four children. Blynn, the eldest, will be 6 years old in 2022. Robin has a salary of $160,000 and Terry earns $70,000. Between shift work and help from parents, their childcare expenses are negligible. They do not live in a communal property state. By producing separately and giving all dependents to Terry, they will increase their overall credits by over $10,000.
Is this enough to compensate for the multitude of disadvantages associated with separate filing? Brent Lipschultz of the Eisner Advisory Group gave me a compelling summary of the obstacles:
Where the tax code can “give some benefit” to separate filing, it can also “take away” from it. For example, earned income tax credit, education tax credits, child and dependent tax credit, and student loan interest are not available to those filing separately.
By filing separately, you are at your spouse’s discretion if he or she takes the itemized deduction, you will need to itemize, potentially losing a 12,550 deduction, if you have nothing to itemize. Separate filers can contribute less to their IRAs and only deduct $1,500 in capital losses versus $3,000 with capital transaction return filed jointly.
There may be an advantage to filing separately if a spouse with a lower income incurs medical expenses that they otherwise could not claim if their incomes were combined in a joint return.
Tax professionals need to sharpen their pencils, analyze all the possible facts and work out the numbers, but you’ll find that the general rule of joint filing holds true in most cases because of the rate table.
There is more. One of you can have passive losses and the other passive income. And filing separately can lead to higher Medicare Part B premiums. This isn’t usually a concern for parents of young children, but it’s one more thing to watch out for.
This particular problem is where Reilly’s sixth tax planning law – Don’t do the math in your ear – comes into play. The pencil of which Mr. Lipschultz speaks is metaphorical. What you need is good software to run multiple versions of returns efficiently.
Why #TaxTwitter and nowhere else?
I spoke with Mike Sylvester of the SBS CPA group in Fort Wayne Ind. He came to the conclusion on the merits of a separate filing for couples with the right combination of children and income. He estimates the median income of clients in his practice at around $160,000. It seems like the sweet spot for the technique is just a bit north of there. He understood this and took training in his company which he then offered to others on #TaxTwitter in order to confirm his results. There were 28 people who accepted it.
He heard from others who had noticed the phenomenon making comebacks in 2020. What he confirmed was that there are a lot of people who disagreed. Mike gets the award for the biggest savings reported by parting ways.
He told me that he had spoken with people who worked at the big commercial preparers and they didn’t seem to verify it. For what it’s worth, I contacted H&R Block with the question and was told they would get back to me when they could. Still waiting.
Take your time if you have it
I’m going to take a risk and say that if you have kids and an adjusted gross income between $150,000 and $400,000, you really need to look into this. To be honest, I’m very unsure about the upper limit. Just run the numbers. If you haven’t filed yet (it’s April 10 as I write this), get an extension so you don’t rush things.
If you have already filed a joint return, there is a problem. You can change to separate filings of a joint filing only up to the original due date of the filing. Mike Sylvester felt lucky to have caught on to it early on, so he was able to pick up on everyone who had already come out.
Who gets it?
I feel like the people who are interested in it are small but not local micro businesses that serve moderately successful people for whom a few thousand dollars is quite significant. As much as I want to be loyal to my school, I have to say that you might have better luck with an Enrolled Agent than a CPA, although we have Mike Sylvester who shines for us.
Based on my survey on reddit, I doubt people doing their own feedback are as aware of this. If you insist on continuous autonomy, be very careful, because there are a lot of pitfalls in the separate repository.
If you are one of those lucky souls whose declaration is made by a big company as accommodation for your parents or your spouse’s parents, they might miss this. I am completely agnostic as to how family offices will handle this.
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