People going through a divorce, yet have not yet finalized their divorce, often wonder if they should file their tax returns as married filing jointly (MFJ) or married filing separately (MFS). Most people’s gut reaction is to file as MFS. Is this a good thing to do or not?
What is the primary benefit of filing Married Filing Separately (MFS)?
The main reason you may want to file as MFS is if you suspect your spouse is either under-reporting your marital income or overstating your marital deductions on your tax return. If this is your situation and the IRS audits your return, the IRS could hold you personally liable for 100% of the taxes due and outstanding as a result of your spouse’s actions. If you have been audited in the past the IRS will likely maintain closer scrutiny on your tax return for at least a 3 year period from the date of the initial audit. If this represents your tax profile and your exposure outweighs the difference in the liability you would incur filing as MFS vs. MFJ then you may want to consider filing as MFS.
What is the difference in tax rates between MFJ and MFS?
To provide some context let’s look at a couple who is making $280,000 in income per year. Let’s assume there is a primary breadwinner in the family who makes $230,000 and the other spouse makes $50,000 in income. Let’s assume the couple’s tax deductions, on a combined basis, amount to $30,000. This results in taxable income of $250,000 for the couple.
According to the 2018 Tax Reform Act, if you file MFJ and your taxable income is between $165,000 and $315,000 the marginal tax bracket is 24%. If you file MFS and your taxable income is between $200,001 and $300,000 you are subject to a 35% tax rate. An 11% difference in tax brackets. Under MFS, if you make between $38,701 to $82,500, then the effective marginal tax bracket under MFS is 22%. Read on to see the impact of filing MFJ vs. MFS below.
Should I file as MFJ or MFS?
To keep this simple we will assign all of the deductions to the breadwinner and also multiply the taxable income by the tax rate noted above. On a technical tax level, we would need to incorporate other variables into this situation. Yet, for purposes of this article keeping the facts and calculations straightforward will allow you to see the bigger picture and follow the logic.
When you apply the tax brackets outlined above the MFJ calculation creates a $60,000 tax liability for the couple. Under the MFS calculation, on a combined basis, the couple incurs a total tax obligation of $88,000. This represents an additional $28,000 in taxes owed to the IRS. This does not take into account how much you might owe to your local state government.
In this situation, to make the decision whether to file MFJ or MFS based on the numbers only, you would need to compare the difference in tax liability incurred (e.g. $28,000 noted above) to your financial exposure that could result from your spouse over reporting deductions or under reporting income. In other words, if the total misreported taxable income results in a tax liability that is significantly higher than $28,000 then you may want to file as MFS. This is just one example, among many decision criteria, of how you may want to evaluate your situation.
Filing MFS does not eliminate the marital tax liability or marital asset
It is important to note if you file MFS you may mitigate your risk of being audited by the IRS but you do not necessary eliminate the risk of being financially responsible for liabilities generated by your spouse while you are married. What does this mean? Until you get a divorce (i.e. the papers are signed, sealed and delivered) all of the financial activities that occur while you are married is still subject to negotiation. A divorce is a negotiation. Until everything is settled the couple is still associated to each other where the assets and liabilities created in the marriage are subject to division.
Therefore if one spouse incurs a higher tax liability under MFS you may still be responsible for the liability as you proceed through your divorce negotiations. Furthermore, a marital asset could come into play in your divorce proceeding if you made payments “on account” to the government in the form of payroll tax withholdings or estimated payments. If you or your spouse are due a refund from the government that refund, as long as you are still legally married, can be deemed a marital asset of the marital estate subject to property division. It would be important to set specific divorce conditions to not be responsible for any obligations incurred by your spouse from the government. How to properly define your divorce condition and the timing of this is beyond the scope of this article.
In summary, if you have an amicable divorce, you may want to file as MFJ not MFS to keep the money “in the family” verses paying it to the government. If you have a contentious divorce then the situation may be more complicated and require additional critical thinking to manage your financial risks.
About the Author
Larry Smith CPA, MBA
Larry is a Founding Partner of Divorce Outcomes, a specialty professional services firm that analyzes, architects and negotiates all of the financial aspects of a divorce.
Since 2003, Larry has worked with divorcing parties as their fiduciary to design sophisticated divorcing strategies that enable clients to preserve and create wealth from their divorce. As a technical financial expert, he uncovers hidden tradable components through various analytical and architectural processes to arrive at desired outcomes. He is an alumni of KPMG and Andersen and has expertise in:
- technical accounting, taxation, business consulting, risk management, M&A
- forensic analysis, performance analytics
- M&A, business valuations, divorce management, family equity transfers, multi-party negotiations, communications management
- advanced process engineering, cognitive performance technologies
If You Have a Question
If you have a question, feel free to contact me at [email protected] or 617-680-5222. The call is free. I will spend 30–60 minutes with you. I will provide you an honest assessment as to where I think you are positioned in your divorce process or answer any questions you have. I may provide you some guidance, insight or advice that you can take with you as you wish. There is no obligation to move forward. The phone call is designed to ease your fears, provide you some options to pursue and a potential road to run on that can lead you down a path to achieve a successful outcome.
About Divorce Outcomes
Divorce Outcomes is a specialty services firm that helps people both domestically and internationally manage all of the financial decisions that arise in a divorce process. We are not attorneys. We are financial experts who partner with our clients as their personal financial advocates. We help our clients:
- manage their divorce process
- uncover hidden financial risks
- architect divorce solutions
- manage ever-changing negotiating positions
- communicate complex financial matters
- close the divorce process as soon as possible
Throughout the process we evaluate our clients’ current wealth-at-risk and architect desired outcomes to best preserve or create wealth.
This communication is for general informational purposes only which may or may not reflect the most current developments. It is not intended to constitute formal advice or a recommended course of action as every person’s situation is unique and different. The information here is not intended to be, and should not be, relied upon by the recipient to make a decision without professional guidance.