I’ve been advising small business owners and individuals on tax saving strategies for close to two decades now and love helping clients keep more of their hard-earned money!
MFJ vs MFS - This is actually a topic that I don't get asked about as often as I should but we at Nisanov Tax Group perform analyses for clients behind the scenes in order to see what the optimal filing status is for them. That said, I do love this question and try to educate my clients on this topic every chance I get. So, let's get into it - the tax code is written with many loopholes, but at the same time, there are caveats in utilizing them.
When choosing the option between married filing jointly (MFJ) vs married filing separately (MFS), we should be aware of the limitation of the MFS position. Let’s first discuss the common limitations and then delve into some overlooked “hidden gems”.
The following limitations fall into the “common” category – and I am saying that purely as a professional who deals with these issues on a yearly basis.
You may be significantly overpaying in taxes if you file as married filing separately and have student loan debt, child care expenses and/or educational costs during the year. The reason being, these deductions are disallowed for married taxpayers who file using the MFS status. To illustrate this, a couple who earns a combined income of $100,000 has one minor dependent child in daycare and one college student (let’s save the children’s age gap for a parenting journal). One parent also has student loan interest from their college days. Assuming they maximize all of these credits (which is not hard to do these days), they may be giving up approximately $3,500 in tax savings (that’s cold hard cash) by choosing to file separately.
One may ask “Why is the tax code written this way? That doesn’t make any sense.” And that’s a valid question. Unfortulately, with tax law, logic is sometimes thrown out the window.
Now, let’s get into the less “common” scenarios – these I really love because they can easily be overlooked.
Rental income/loss is generally passive in nature and, unless you are a real estate professional, you cannot offset your rental losses against ordinary income. However, there is a tax loophole that allows you to deduct up to $25,000 of losses against your ordinary income if you earn below $150,000 (this deduction is phased out between $100,000 and $150,000). So, going back to the happily married couple from the above, let’s assume the wife owns a rental property, and let’s further assume that they do not live in a community property state. The property showed a loss of $25,000 during the year. If they file using the MFJ status – they can take full advantage of the $25,000 loss and deduct this amount against their income. This would equate to an extra $3,000 in their pocket when they file their tax return. Now, if they file as MFS – the loss is disallowed. It doesn’t go away, per se, as it’s suspended to a future year when the taxpayer has income to offset it, but I’d take the $3,000 today (time value of money = $1 today is worth more than $1 tomorrow).
One of the most beneficial deductions introduced in the Tax Cuts and Jobs Act (TCJA) was the Qualified Business Income (QBI) deduction. This essentially allows taxpayers to deduct up to 20% of their income from a trade or business (think Schedule C, partnerships and S corporations) from their income. This can potentially be HUGE! So, going back to the couple above, let’s assume the wife set up a TikTok store and closed the year with $200,000 of net profit. If we add this income to her current income, it brings her to $250,000. If she chose to file MFS, she would not be eligible for the QBI deduction as it fully phases out at $232,100 (with a phase in limit starting at $182,000). Had she and her husband filed as MFJ, she would have been able to take the full advantage of the deduction which would have yielded a $40,000 subtraction from total income, significantly lowering their taxable income.
But the above example is an extreme. A not so obvious scenario recently occurred with a client of ours who had historically filed as MFS. Their income allowed them to take advantage of the QBI deduction, but it was still limited due to the phase out of the deduction. When we ran the numbers, we found that filing MFJ yielded an additional $9,000 of QBI, resulting in a refund of approximately $3,000.
Filing as MFS is not always a detriment. There are times where it could benefit certain taxpayers. For taxpayers who perhaps do not have educational, student loan or child care expenses but have high medical expenses in a particular year, it may make sense to file MFS as the income threshold for medical expenses are much lower when considering only one spouses’ income. Medical expenses are limited to 7.5% of AGI. If both spouses have similar itemized deductions that already exceed the standard deduction, splitting the returns can significantly benefit the other spouse when it comes to medical expenses. Keep in mind, when filing MFS, both spouses must be consistent with their deduction type – either both take the standard or itemized deduction.
Couples that have large student loans may also wish to consider filing as MFS. Despite not qualifying for the student loan deduction, they may, instead qualify for lower monthly repayments if their loans are subject to income based repayment options.
One thing to remember, if you file MFS and then decide to file as MFJ (perhaps after reading this article), you are allowed to do so by filing an amended tax return. You cannot, however, change your filing from MFJ to MFS – so choose wisely.