Differences in Tax Liability
Unfortunately, there are no simple rules of thumb to determine the differences in tax liability for filing joint vs. separate returns. The only way married borrowers can be certain is to ask their tax preparer to calculate the tax liability each way and then compare the results. A lot depends on the individual circumstances, such as whether there is a significant difference in income and whether the partner with the lower income also had significant itemized deductions subject to an AGI limit. If the incomes differ enough that the two borrowers are in different tax brackets, an averaging effect reduces the tax bracket for the spouse with the higher income. Some itemized deductions, such as medical expenses, casualty losses and miscellaneous itemized deductions (e.g., unreimbursed employee business expenses, fees for tax advice and preparation, and investment expenses), are subject to an AGI limit or threshold, so filing separate returns may allow the couple to claim deductions that would otherwise be denied. Couples who file separate returns, however, lose a variety of tax deductions and credits. Some of the lost deductions and credits are related to education, such as the student loan interest deduction, Hope Scholarship tax credit, Lifetime Learning tax credit, tuition and fees deduction and deduction for interest on series EE savings bonds used for higher education expenses. Separate filers also lose the child and dependent care tax credit and the adoption expense tax credit, as well as the ability to deduct contributions to an IRA or Roth IRA in certain circumstances. The deduction for capital losses is split in half if the couple files separate returns. The benefits of filing separate returns also depends on whether the couple lives in one of the nine community property states (Arizona, California, Idaho, Louisiana, New Mexico, Nevada, Texas, Washington and Wisconsin), in which case income is averaged. Most families save more on their taxes by filing a joint return, but the lower monthly loan payments under IBR may save enough money to offset the higher tax bill. For example, the example discussed above involves taxpayers who are both in the 15% tax bracket regardless of their filing status, so there are no tax savings from filing as married filing jointly. The couple will save more by filing separate returns to reduce the loan payments. If one of the borrowers qualifies for public service loan forgiveness, the benefits of filing separate returns to achieve a lower loan payment under IBR are even greater, since the borrower's remaining debt will be forgiven sooner.