When separated spouses file their income tax returns, they generally have a choice of filing jointly or separately. If they file jointly, they may have to decide how to allocate the tax liability or refund. If they file separately, they may have to decide how to allocate itemized deductions, the children’s dependency exemptions, and credits. The advice of a competent tax preparer, CPA or tax lawyer can be most helpful.
One of the leading authorities on divorce taxation, Melvin Frumkes, declares that “a couple with only one income producer will benefit from filing joint returns; that is, until their marriage is dissolved.” Still, the only sure way to know is to have an accountant run the figures both ways. Most tax preparation software used by professionals can calculate the taxes both ways without much additional expense. Just be sure that the tax preparer considers the alimony deduction (if any) and proper allocation of itemized deductions, dependency exemptions, and credits (including payroll withholding and estimated payments).
Whether filing jointly or separately, these are four key issues to consider:
1. Filing status. Spouses who file separately may save money by electing the head of household status if they qualify. While dependency exemptions can be transferred between spouses to maximize their effectiveness, filing status cannot be transferred. Some tax preparers believe that separated spouses may elect “single” filing status, but it might be risky, especially if the other spouse elects “married filing separately” status.
2. Alimony and itemized deductions. In Pennsylvania, spousal support paid during the separation and “unallocated” child and spousal support are generally treated as alimony for tax purposes. The paying spouse may deduct the payments from taxable income, and the receiving spouse must declare the income. When spouses file jointly, they cannot claim the deduction because the income wipes out the deduction. Thus, filing jointly confers a benefit on the receiving spouse who might otherwise have to pay income tax. Yet, in many cases, a joint return confers tax savings on the paying spouse that exceed the benefit of the alimony deduction. Separated spouses can agree to share the tax advantage of joint filing so that both spouses benefit.
When filing jointly, estranged spouses can pool their itemized deductions to maximize their tax savings. When filing separately, however, they have to allocate income and itemized deductions associated with jointly-titled assets. The bank might issue a joint statement for qualified mortgage interest and real estate tax deductions. Yet, the IRS might not assume that those deductions should be allocated equally. It is advisable to consult with a tax accountant or review the tax regulations before claiming your share of joint deductions or income. Separated spouses should communicate with each other to avoid discrepancies that could trigger a deficiency notice or IRS audit.
3. Payments and credits. If spouses file jointly, all of their withholding, estimated payments and credits may be applied to reduce tax liability. If the spouses file separately, the IRS will recognize an agreement between the parties to allocate their estimated payments made in the year following a joint return. If the spouses do not agree, then the payments are allocated in proportion to the spouses’ tax liabilities as reported on their separate returns. Withholding is allocated to the spouse who paid it. Credits (such as the child tax credit and earned income credit) are more complex and require a careful analysis of the legal requirements.
4. Unreported income and erroneous deductions. An entire body of law has developed around the issues of unreported income and erroneous deductions. If your spouse is working “under the table” or does not report all of the income from a business or professional practice, the best advice is to file separately. Underporting income or claiming false deductions can lead to additional tax, interest, and severe penalties. The IRS has created procedures to provide relief for taxpayers who file joint returns with a tax-cheater, but it is better to avoid that issue completely by filing separately.
CONCLUSION: Every taxpayer is responsible for filing an accurate tax return and paying their share of taxes. Yet, every year I hear stories about people who simply trusted their estranged spouse to take care of it; they were surprised to find out later that their spouse filed an inaccurate return, filed a separate return, or didn’t file at all. Don’t rely on someone else to file your tax return without checking it before it is filed; and don’t wait until the last minute!
These tips and more are discussed at length in Publication 504, “Divorced and Separated Individuals,” available here on the IRS website. Pursuant to applicable US Treasury Regulations (Circular 230), I must advise you that this article is not intended or written to be used, and cannot be used, by a reader for: (i) avoiding tax penalties that may be imposed on the reader under US Federal Tax Laws or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Instead you have the right to, and should, seek independent tax advice.