Tax Returns Couples who have filed their tax returns jointly for their entire marriage may find that it is more beneficial to file separately in 2021. The COVID-19 stimulus bills passed by Congress in the past two years have introduced new factors such as Economic Impact Payments (EIP) and Recovery Rebate Credits (RRC), which may dramatically affect tax calculations. Married taxpayers in particular will want to evaluate how pandemic-related credits might change their tax situation this year. Filing separately could result in more money in these taxpayers’ pockets, but this route also comes with its own unique complications. To weigh the pros and cons, read on and consider contacting a Certified Tax Planner for expert advice.
CONSIDER INCOME THRESHOLDS
The American Rescue Plan Acts of 2021 (ARPA) authorized stimulus payments of $1,400 to US taxpayers and their dependents. These payments were subject to income thresholds depending on their filing status:
● Single and Married Filing Separately (MFS): $75,000 in adjusted gross income (AGI)
● Married Filing Jointly (MFJ): $150,000 in AGI
Taxpayers whose annual income comes in below those thresholds received the full payment, and above the threshold, that amount gradually phased out as income levels rose. Once a taxpayer’s AGI reached $80,000 for Single and MFS or $160,000 for MFJ, they would no longer be qualified for a stimulus check.
One tax planning opportunity arises when a couple has joint income over $160,000 but a disparity in their individual incomes. One person’s individual income may not qualify them for a stimulus payment, while the other’s income might if calculated individually. The IRS was required to send out advanced stimulus payments in 2021, but taxpayers who did not receive the advanced payment can claim a credit on their tax return as an RRC. This is one instance where it may make sense for a married couple to file their 2021 taxes separately.
FACTORING IN DEPENDENTS
When two parents living together file MFS returns, either parent may claim their child as a dependent. If multiple children live in the household, the decision of who will claim a dependent can be made on a per-child basis. This opens up additional tax planning opportunities. If one parent is over the AGI threshold and the other parent is not, the parent with the lower income can claim the children as dependents and receive the RRC.
OTHER CALCULATIONS TO MAKE
Electing the Married Filing Separately status also comes with limitations. In many scenarios, filing two MFS returns can result in a higher combined federal tax liability compared to filing jointly. Couples will need to calculate the two options in advance to determine if the RRC benefits outweigh the increase in total tax liability. This is where the assistance of a Certified Tax Planner can prove invaluable, to ensure you are accurately estimating potential taxation. Taxpayers also need to factor in any state-level taxes, if relevant, and the cost of double tax preparation. In some situations, withholdings may not be correctly distributed between a married couple, so when their tax returns are separated, one spouse will have a tax payment due, and the other spouse will receive a large refund. If this is the case, any potential underpayment penalties or—if the return is on an extension—interest and late payment penalties will need to be included in the calculations.
DRAWBACKS OF FILING SEPARATELY
While the opportunities mentioned above are certainly worth weighing, filing MFS can have significant disadvantages, including the loss of certain tax credits and deductions. These include the Earned Income Credit, Child and Dependent Care Credit, education credits, and student loan interest deductions. Taxpayers who select Married Filing Separately will no longer be eligible for these credits. An MFS status can also create complications around social security income, itemized deductions, and the ongoing Advanced Child Tax Credit payments. Furthermore, if the couple lives in a community property state, which requires equal distribution of assets acquired during a marriage, MFS tax returns can become particularly messy.
Taxpayers should also factor in the IRS processing issues that came up during the pandemic. In some cases, couples filing MFS in 2020 received notices from the IRS incorrectly “recalculating” their RRC benefits. Taxpayers then have to invest time and effort into contesting these recalculations—given the ongoing problems with an underfunded and overextended IRS, taxpayers may not want to spend energy making a case that they are eligible for additional tax credits.
The pandemic-related stimulus benefits add a layer of complexity to filing decisions for couples. Married taxpayers need to be aware of all the factors that could impact their tax liability and eligibility for various tax credits in 2021. Due to the Recovery Rebate Credit, some couples may find they could end up with more money in their pockets if they file separately, in spite of the initial increase in combined taxes.
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