Money is the first cause of divorce, as much as 57% of couples cited financial issues as their main disagreement. Troubles include not talking about money; power plays around earning and irresponsible spending, in particular by the spouse who is not the primary breadwinner.
A successful marriage requires compatibility on many levels, and although personality, hobbies and the desire to have children appear more often in conversations, the financial agreement should be on top of the list. One of the most important aspects to consider is the way a married couple does their taxes and how they can be savvy about this.
The Tax System
To make the most out of your situation, you need to understand how the system works. The income taxes are gradual, according to the total revenue. A person can file for taxes as single (not married, but could be in a domestic partnership), married filing jointly (MFJ), married filing separately (MFS) or head of household if you are single, divorced, legally separated and in charge of at least one qualifying person.
Each year the IRS announces the tax brackets. In 2017 the married filing separately brackets are exactly half of the married filing jointly brackets, as you can see below. This is done to prevent “marriage penalty,” namely a higher income tax for those who get married and their combined salaries push them in another tax bracket. This is only valid for spouses earning almost the same, for all the other cases, there are different strategies to pay as little as legally possible.
There are different tax brackets for singles and head of households, but we will focus on legally married couples for now. A person’s status is determined by the last day of the tax year, so even if you tied the knot in December, you would still file as married. The same applies to people who were widowed during the tax year, but not to divorce. The widowed can file as married, usually getting a better rate, while separated can file as single or head of household.
Filing Jointly or Separately
When taking this decision, you should look at your combined incomes first and your expenses next. Most couple file together and this is a great option if you are in the same earning bracket or if one spouse earns a lot more than the other. This is also easier from a logistic perspective, but in this case, each of you is liable for the other’s mistakes, as the form is signed by both parties. You are not responsible for your spouses’ tax filings before you were married or for the mistakes/omissions you can prove you were not aware of, but that is hard to prove.
Filing separately makes sense when both of you are high earners, but if you combine the incomes, your family ends up in a higher bracket without doubling the amount. Usually, the difference is too small to justify the hassle of creating individual forms. Filing separately makes sense when one of the spouses has significant medical expenses, charitable contributions that are deductible or child support for children from previous marriages. It also makes sense for spouses who have already filed for divorce and are awaiting final court resolution and for those living separately who want to qualify as head of household.
Be careful if you are not in one of the situations since filing separately can disqualify you from deductions and tax breaks such as:
- Tax-free exclusion of Social Security benefits;
- The credit for the elderly and disabled;
- The deduction for college tuition expenses;
- The student loan interest deduction;
- The American Opportunity Credit and Lifetime Learning Credit for higher education expenses;
- Net Capital losses deduction of
- Traditional/Roth IRA deductions;
Itemize or Standard Deduction
You can either claim a standard deduction each or, if you have the patience and the knowledge, you can itemize deductions in the hope you can get some money out of the taxable income. The standard deduction is $6.350 per individual, and it doubles, $12.700 for MFJ.
In the case of married persons, both spouses must take the same decision, so it is either standard deduction for both or itemized. The itemized case should be taken into consideration if at least one spouse can benefit from several deductions. This benefit stops at what is called the Pease threshold ($156.900 MFS and $313.800 MFJ).
Making the Best
Most employers offer benefits for the families of their staff, so married couples usually have the choice of getting a benefit from their spouse’s package. This can include IRA funds, benefit plans for dependent children or medical insurances.
Speaking of IRA, if one of the spouses does not have a job, they can still contribute to an individual retirement account through the joint income. This is possible through the higher threshold for married couples than for single people.
If you intend to sell the house, you owned together, get ready to benefit from a tax exemption of up to $500.000 if it has been in possession of at least one of you in the last two years of the last five, but you both used it to live there.
The law does not allow anybody to use his or her spouse as a dependent person, even if he or she earns no income of his or her own. This case is called personal exemption. The amount of this personal exemption is $4050 for 2017. High-income earners (over $384.000 MFS or $436.300 MFJ) can’t benefit from this.
If one of the spouses passes away, the surviving spouse can inherit any amount of estate, with the tax being deferred. This does not mean there are no fees to be paid but gives the inheritor time to make better arrangements.
Conclusion- Talk about money
There has been much talking about a marriage penalty, but as described, if the partners are open and knowledgeable about their finances, marriage can, in fact, have positive effects on a couple’s finances. It is mandatory to take some time and ask your significant other to have a fiscal date. Pour a glass of wine and take out the income statements and other paperwork and try making the computations for different scenarios to find the best solution in your case.
If you think you do not have time for that, are not parents yet, and each of your incomes are not over six figures, you can be better off filing jointly and taking your standard deduction. When you become parents, it might be time to reassess your situation and finances.