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Impact of Tax Filing Status on Income-Based Repayment for Married Borrowers

Mark Kantrowitz

March 19, 2012

Detailed Example of Tradeoffs of Filing Jointly/Separately

Married borrowers will need to compare the tradeoffs between a potentially higher tax bill and lower IBR payments when filing separate income tax returns instead of a joint income tax return. Married taxpayers who file separate returns lose some tax deductions and benefits, such as the student loan interest deduction. But the loan payments under IBR might be lower if they file separate returns.

For example, consider a married couple with cumulative federal loan debt of $65,000 and $175,000 and corresponding income of $20,000 and $33,000. Assume that the borrower’s income will not be increasing in subsequent years. It is clear that such a couple needs income-based repayment because their debt exceeds their income. Their debt-to-income ratios are 3:1 and 5:1 separately and 4:1 combined.

If a borrower’s debt-to-income ratio is greater than 1:1, the borrower will need to use an alternate repayment plan like extended repayment or IBR in order to afford the monthly loan payments. If the debt-to-income ratio is greater than 2:1, IBR is the only affordable choice. At a combined 4:1 debt-to-income ratio, the monthly loan payments would represent more than half of the combined AGI with a standard 10-year repayment term and almost a third of the combined AGI with an extended 30-year repayment term.

The only question remaining is whether the couple should file separate returns or joint federal income tax returns. (Note that if one or both of the borrowers were to have a significant increase in income, to the point where annual income exceeds that borrower’s total debt, that borrower might then lose eligibility for IBR. But until then IBR is the only option that yields an affordable monthly loan payment.)

The monthly loan payment under IBR equals 15% of monthly discretionary income. (Pending changes would reduce this percentage to 10%, but only for new borrowers with at least one loan in 2012 or a subsequent year.) Discretionary income is the difference between AGI and the poverty line for the family size. Monthly discretionary income divides this result by 12. The 2012 Poverty Line for a family of 2 living in the continental US is $15,130. 150% of this is $22,695. This is all the information that is needed to calculate the IBR loan payment in each of the two scenarios.

Married Filing Separately. If the married borrowers file separate returns, the borrower with the $33,000 income will exceed 150% of the poverty line by $10,305, yielding a monthly payment of $129. The borrower with $20,000 in income is less than 150% of the poverty line, yielding a monthly payment of $0. The combined monthly loan payment is $129.

Married Filing Jointly. If the married borrowers file a joint return, the combined monthly payments under IBR will be based on the combined AGI of $53,000, which exceeds 150% of the poverty line by $30,305, yielding a combined monthly loan payment of $379.

So the couple’s monthly loan payment is $250 lower if they file separate returns. That works out to be a savings of $3,000 per year. (Note that this result is specific to this example’s particular set of income and debt figures. If the couple’s income increases, there may be a different outcome. Borrowers should always use an IBR calculator to customize the results to their specific circumstances. Generally, the monthly loan payments under IBR will be lower if the couple files separate returns, especially if one or both of the borrowers has income below 150% of the poverty line.)

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