Tax Law: Should Married Couples File Separately?

Summary

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Podcast Summary: WSJ Your Money Briefing

Episode: Tax Law: Should Married Couples File Separately?
Date: February 26, 2018
Host: JR Whalen
Guest: Laura Saunders, Wall Street Journal reporter

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Overview

This episode explores whether married couples should consider filing their taxes separately under the new tax law that came into effect for the 2018 tax year. The discussion zeroes in on how the 20% pass-through business deduction could change filing strategies for some couples. Wall Street Journal reporter Laura Saunders walks listeners through the benefits and drawbacks of "married filing separately," and under which circumstances it might make financial sense.

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Key Discussion Points & Insights

1. Prevalence and Basics of Filing Separately

• Filing separately is uncommon:

  • Only 3 million out of 150 million tax returns were filed as "married filing separately" in 2015 ([00:47]).
  • The status has more drawbacks than benefits for most people.

• Major change due to new tax law:

  • The 2018 tax overhaul introduced a 20% pass-through business deduction with income limits that are lower for individuals than for married couples filing jointly ([01:16]).

2. Who Might Benefit from Filing Separately?

• Pass-through Deduction Scenario:
  • If one spouse earns a high salary and the other has a pass-through business (like a therapy or medical practice) making under $157,500, splitting their incomes and filing separately could allow the lower earner to fully qualify for the deduction ([01:39]).
  • “You might be able to get the tax deduction for the lower earner by splitting their incomes and filing separately.” – Laura Saunders ([01:52])

3. Why File Separately Even Before the Tax Law?

• Historical reasons:

  • The system has a “very strange tilt” with marriage bonuses and penalties shifting over time, often making joint filing better ([02:31]).

• Potential drawbacks:

  • "Marriage filing separately takes away a lot of benefits ... Like you can't have an American Opportunity tax credit and you can almost never deduct an IRA contribution." – Laura Saunders ([02:50])
  • Still, it can make sense in specific cases:
    • Liability concerns: If you suspect your spouse is engaging in tax fraud, filing separately severs joint liability ([03:35]).
      • “When you sign a joint return, you are jointly liable and that can be disastrous in some cases. But if you file separately, you sever the liability. You're only responsible for your own taxes...” ([03:35])
    • State taxes: In certain states, such as Ohio, filing separately may be advantageous for state, even if costs a bit federally ([04:02]).
    • Medical expenses: If one partner has significant medical costs, dividing incomes can sometimes allow for larger deductions ([04:14]).

4. Caveats and Complications

• Federal Incentives:

  • Historically, rules encouraged joint returns, and this is likely to remain mostly unchanged for most couples, despite the new deduction ([04:55]).
    • “I think most people will continue to file jointly if they're married...” – Laura Saunders ([04:56])

• Technical and Practical Issues:

  • Community Property States: Splitting income may be difficult or require legal steps.
  • IRS Processing Glitches:
    • If estimated taxes are paid by one spouse, and returns are filed separately, IRS computers may misallocate payments.
    • “They'll send one person a big refund and the other person, they'll start dunning them for their taxes. So the computers have a hard time putting that back together.” – Laura Saunders ([05:55])

• Overall Message:

  • Filing separately is "a very strange new world," full of complications, and rarely the best choice outside special situations.

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Notable Quotes & Memorable Moments

• On new deduction:

  • "It's a special deduction for people who pass through business owners, you know, to encourage business economic growth and things like that. And it has a kind of a limit that kicks in at $157,500 or $315,000 of taxable income for married couples." – Laura Saunders ([01:23])

• On risk of joint liability:

  • “When you sign a joint return, you are jointly liable and that can be disastrous in some cases. But if you file separately, you sever the liability. You're only responsible for your own taxes and not whatever terrible things that your spouse may be doing.” – Laura Saunders ([03:35])

• On IRS confusion:

  • “If two people file separately but one of them pays estimated taxes for the couple, then the IRS can get confused about that... So the computers have a hard time putting that back together.” – Laura Saunders ([05:45])

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Key Timestamps

• 00:47: Statistics on joint vs. separate filings.
• 01:16: Introduction of new tax law’s significance.
• 01:39: How pass-through deduction changes the math for filing status.
• 02:31: Historical and systemic reasons for joint filing dominance.
• 03:35: Liability concerns and separation.
• 04:02: State-specific filing strategies.
• 04:14: Medical expense deduction strategies.
• 04:55: Continued federal incentive for joint filing.
• 05:45: Practical IRS processing issues when filing separately.

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Conclusion

The episode delivers a clear, nuanced look at why "married filing separately" is rare but is getting a fresh look thanks to the 2018 tax law’s pass-through deduction. Laura Saunders emphasizes the technical, financial, and legal complexities of this filing status. While some couples may benefit, particularly with specific income and business scenarios or state tax rules, most are still likely better off filing jointly—unless they have unusual liability or deduction considerations.

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Transcript

[A]

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[B]

Is yous Money Matters from the Wall Street Journal. Welcome to youo Money Matters. I'm JR Whelan in New York. Millions of married American couples file their taxes jointly. That's not a surprise. What may come as a surprise is that the new tax law could make it more financially attractive for married couples to file separately. And Wall Street Journal reporter Laura Saunders joins us to discuss. So, Laura, in 2015, that's the last set of IRS data we have. Only 3 million out of 150 million tax returns were filed as married filing separately. And it might benefit couples to file that way for the tax year. 2018 has a lot to do with the new 20% pass through business deduction.

[C]

Yes, that's exactly right. Married filing separately is a very strange filing status. As you said, it's only 3 million out of 150 million returns because it has a lot of detriments and only some benefits. But the tax overhaul will probably change that to an extent because there's a special deduction for people who pass through business owners, you know, to encourage business economic growth and things like that. And it has a kind of a limit that kicks in at $157,500 or $315,000 of taxable income for married couples. And so what happens if one person makes a big salary in wages, but the other person has a business or a psychotherap therapy practice or something like that, or is a doctor and makes less than $157,000? In that case, you might be able to get the tax deduction for the lower earner by splitting their incomes and filing separately. But then you go into this strange new world of married filing separately.

[B]

But, you know, even before the new tax law was even a twinkle in Washington's eye, going back several years, why would married couples want to file separately?

[C]

Well, that's an interesting point because very often it raises taxes and it's the legacy of a very strange tilt in the tax system. First there was a marriage bonus for people who were for married couples where there was one earner. Then they tried to make it better for singles and that was bad for two earner couples and so forth. So it's a very strange system. Marriage filing separately takes away a lot of benefits that you get. Like you can't have an American Opportunity tax credit and you can almost never deduct an IRA contribution. But if you're not doing those things, it could benefit you, especially if you have this new tax break. But let me talk about the times when has always made sense to file separately. The biggest one is that you've got. You think that your spouse may be cheating and when you sign that joint

[B]

return, you are jointly cheating romantically or financially.

[C]

Oh, sorry, excuse me, cheating financially cheating with the irs, to be specific.

[B]

Okay.

[C]

When you sign a joint return, you are jointly liable and that can be disastrous in some cases. But if you file separately, you sever the liability. You're only responsible for your own taxes and not whatever terrible things that your spouse may be doing. So that's a really important thing. Other reasons to file separately might have to do with state taxes. Like in some states it makes sense to file separately. We had a source who said his Ohio clients always file separately. And then they file separately on the federal return too. And that costs them a little bit of money, but they make a lot on the Ohio side of things.

[B]

And that really depends on the state you live in.

[C]

It does depend on the state you live in. Another reason would be that one partner has a lot medical expenses. You know, somebody's in a nursing home. And if you split the incomes, it becomes easier often to take a much larger deduction. All this is explained in the story, or at least the questions to ask of a professional.

[B]

All right, we're speaking with Wall Street Journal reporter Laura Saunders. And you're listening to youo Money Matters from the Wall Street Journal. Welcome back, everybody. So, Laura, rules passed by Congress over the years actually encouraged couples to file jointly. That's really up until now with the pass through law. But up until now, the rules really tilted toward couples filing jointly.

[C]

Yes, and I think they still will. I think most people will continue to file jointly if they're married, but it just could tilt a little bit the other way because of the new pass through deduction.

[B]

And then by paying estimated taxes, if one spouse does that, it can result in processing issues at the irs.

[C]

Well, I think it's important to pull back and say that there are all kinds of caveats. If you plan to.

[B]

We should just say that we're talking now about filing separately in this scenario.

[C]

If you are married filing separately instead of jointly, there are all kinds of things to be aware of. You might lose a lot of tax breaks, your taxes might go up, but you would sever the liability. Now, other glitches could have to do with things like if you live in a community property state, it may be hard to do that. You may have to get a court order or take special measures to separate property. And the other thing is there can be processing glitches at the irs. If two people file separately, but one of them pays estimated taxes for the couple, then the IRS can get confused about that. And it takes a lot of time to. To work it out because they'll send one person a big refund and the other person, they'll start dunning them for their taxes. So the computers have a hard time putting that back together.

[B]

We've heard it's all within the framework of the rules, and yet the computers could get confused.

[C]

Exactly.

[B]

All right, leave it to the irs. All right. That's the Wall Street Journal's Laura Saunders joining us here in our studio. Laura, thanks for being with us and thank you. And thank you for listening to youo Money Matters. I'm JR Whalen in New York for for the Wall Street Journal.

[A]

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