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Should Married Borrowers File Joint or Separate Federal Income Tax Returns with Income-Based Repayment?

Mark Kantrowitz

October 29, 2012

I have a question about a joint consolidation loan and income-based repayment (IBR). My wife and I consolidated our loans jointly about 10 years ago (when such things were allowed). My name is at the top of the loan. My wife and I both individually had about $70,000 in loans and our joint loan was $140,000. It is currently at about $150,000 owed. I make an adjusted gross income of $60,000, and my wife (due to health issues) cannot work and has no income. We have one child. When I run the IBR calculator it looks like our loan payment should be about $400/month if we file jointly. If we choose to file separately, each tax return will show an AGI of $30,000. (We live in Washington, a community property state.) Assuming the tax liability was similar either way (I believe the only deduction we would lose is the student loan interest deduction), would we have a separate IBR amount for each of us based on the $30,000 (approximately $20/month each)? — S.W.

The answer to this question applies to all married couples with student loans, without regard to whether their loans were jointly consolidated or kept separate.

When there is a mismatch between income and debt, where total student loan debt exceeds total annual income, the borrowers should consider using income-based repayment (IBR). With $150,000 in student loan debt and $60,000 a year in income, there’s a debt-to-income ratio of 2.5 to 1. Clearly, borrowers with such a high debt-to-income ratio need IBR.

The only question is whether the couple should file joint or separate federal income tax returns.

When a married couple files joint returns, eligibility for IBR is based on the joint income and the couple’s total student loan debt. The monthly payment under IBR is then based on the joint income and applied in proportion to the loan balance to all the loans.

When a married couple files separate returns, eligibility for IBR is based on each taxpayer’s separate income and just the taxpayer’s own loans. (With a joint consolidation loan, each spouse is responsible for the full loan amount and so the full loan counts toward each spouse’s separate eligibility for IBR.) The monthly payment under IBR for each borrower is then based on just the borrower’s income and applied to only the borrower’s loans.

The monthly payment under IBR is based on a percentage of the borrower’s discretionary income. Discretionary income is the amount by which adjusted gross income exceeds 150% of the poverty line for the family size. The same family size is used regardless of whether the borrower files joint or separate income tax returns.

In effect, married borrowers who file separate returns get to count the poverty-line offset twice. This treatment is intentional, designed to compensate for a marriage penalty inherent in the IBR formula.

From a practical perspective, this means that the total monthly payments under IBR will be lower when the couple files separate returns if both spouses have non-zero income. More of the income will be masked by the poverty-line threshold. If the separate income is closer to the poverty-line threshold, it can yield significantly lower monthly payments. In most cases the loan payments will be reduced by hundreds of dollars per month.

For example, $60,000 in joint income with a family size of 3 will yield an initial monthly payment of about $392, since 150% of the poverty line is $28,635. But if each spouse files separate returns with $30,000 in income, that income is much closer to the $28,635 threshold, yielding much lower initial monthly payments of about $17 each, or a total of $34.

In a community property state, each spouse is assumed to have earned half of the joint income. Thus married couples living in community property states who repay their student loans under IBR will almost always have lower monthly payments if they file separate income tax returns.

The main drawback with filing separate returns is that some tax deductions and exclusions, like the student loan interest deduction, are restricted to couples who file joint returns.

(In a joint consolidation loan, if one spouse is unable to work because of health issues, and that spouse obtains a total and permanent disability discharge, only the portion of the joint consolidation loan that is attributable to the disabled spouse’s loans will be discharged, per the regulations at 34 CFR 682.402(a)(2). The other spouse will remain obligated to repay the rest of the joint consolidation loan.)

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