From the November 2006 issue of Wealth Manager Web • Subscribe!

November 1, 2006

Joint vs. Separate

Our filing status on a Form 1040 is a category that identifies you based on your marital and family situation. More than one filing status may apply to your client, in which case the law allows the taxpayer to choose the one that grants the lowest tax obligation. There are five possible filing statuses: Single; Married Filing Jointly; Married Filing Separately; Head of Household; or Qualifying Widow(er) with Dependent Child. For instance, parents who file as head of household usually qualify for a higher standard deduction and pay tax at a lower rate than single taxpayers and married couples filing separately. Which is best for your client?

This is not a one-time decision. Each year stands on its own--married couples have the option to file either jointly or separately in any given year. Note that each spouse becomes responsible for the entire tax liability on the jointly filed 1040, as well as for any increase in that liability due to the other spouse's understatement of income or overstatement of deductions and credits. So while the bliss might have ended, the Feds are still around; the tax code authorizes them to keep both spouses tethered to their old joint liabilities long after every other bond that connected them has been sundered. And it makes no difference that one spouse has since kicked the bucket. Or that the additional taxes are attributable to the deceased spouse's business or income. Or even that a divorce decree states that one spouse is responsible for previous joint returns.

The rules are not inflexible, however. Several relief provisions permit divorced persons to make a clean and permanent break with any tax irregularities of their former spouses. But proving that one qualifies for relief often requires expensive help from an attorney or accountant.

An anxious spouse in a disintegrating marriage can help forestall problems by making sure to file a return with a check in the box "married filing separately"--something a taxpayer can do even if he or she has no reportable income and is not required to file a return. The IRS might seek to foist responsibility for a joint return on someone whose spouse forged a signature. However, submission of a married-filing-separately return helps establish an intent to not file jointly.

When spouses file separate returns, each spouse signs, files and is responsible for his or her own return. Each reports his or her own income, credits and exemptions, but they have to agree on which return will show the personal exemptions for any children. Another stipulation: One spouse can use Form 1040's Schedule A to itemize for deductions like charitable contributions and state income taxes only if the other itemizes as well. If they do itemize, they must decide on how to allocate between the two returns the deductions for outlays like mortgage interest and real estate taxes on a personal residence. Otherwise, both have to use the standard deduction.

Spouses who file separately and are not living apart suffer the reduction or loss of certain tax breaks. These include the deductions for losses from rental properties or sales of investments and for interest payments on student loans; the credits for child- or dependent-care expenses and for education (Hope and Lifetime Learning); and the extent to which Social Security benefits are taxed.

Different rules apply for couples in the community property states--Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. Their separate returns must show identical amounts of income: That is, one-half of the combined community income. It makes no difference that the couple is physically separated, and neither has shared one dime with the other over the course of the year.

Married couples usually fare better by filing jointly rather than separately. But to be sure, they need to work through the numbers both ways. Separate returns might be more advantageous when, for instance, one spouse has a relatively low adjusted gross income and substantial deductions for certain kinds of itemized deductions, such as medical expenses not covered by insurance, or casualty and theft losses not covered by insurance or otherwise reimbursed. (It might be wise to consult a CPA familiar with the details.) Taking such expenses on a separate return that reports less AGI than a joint return makes more of the expenses deductible.

The lesson in all this for advisors? Knowing the complexities of the tax code is important, but not enough. Tax planning, along with other aspects of the engagement, is dependent on each client's particular situation.

Julian Block (www.julianblocktaxexpert.com) is a syndicated columnist and attorney based in Larchmont, N.Y. His books include Marriage And Divorce: Savvy Ways For Persons Marrying, Married Or Divorcing To Trim Their Taxes To The Legal Minimum.

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