In the 35 years plus of being a CPA I have filed a married filing separate return on an elective basis likely less than 20 times (some couples prefer to file separately). With the new Section 199A 20% of business income deduction being limited to various phase-outs, 2018 may be a tax year where I file several extra separate tax returns. Here are some of the times where it may make sense to file separately:
- One spouse has a high source of income and the other spouse has specified service business (SSB) income. Once a married couple goes over $415,000 of taxable income, none of the SSB income will qualify for the 20% deduction. However, if the spouse with the SSB income is under $157,500 of taxable income (before the 199A deduction), they may qualify for a full 199A deduction on that income.
- Each spouse has qualifying income, however, due to being over the threshold levels, the phase-out based on wages or qualifying property may lead to a substantially reduced Section 199A deduction for one or both spouses.
Here are examples for both situations:
John is an employee of ABC Farm Goods Inc. and earns a wage of $300,000. Mary, his spouse has a Schedule C SSB business that earns $180,000. They utilize the standard deduction. If they file joint, they owe about $107,280 of federal income tax. If, instead, they elect to each file separate income tax returns, John will owe about $76,490 of tax and Mary will now have a Section 199A deduction of $31,486 (limited to 20% of taxable income). This results in tax of $24,516 which when added together equals $101,006 saving $6,273.
Bert and Ann are farmers. Bert has a S corporation that pays him $100,000 of wages and nets $200,000, thus qualifying for a $40,000 Section 199A deduction. Ann has a Schedule F that generates $180,000 of income, however, she pays no wages and has no qualifying property. The tax owed by a joint filing is $93,279 ($40,000 Section 199A deduction allowed for Bert, nothing for Ann). By filing separate, their total tax is reduced to $87,006 saving the same $6,273 as John and Mary since Ann is allowed the same extra $31,486 deduction.
Although there is not a huge savings from filing separately, the cost of preparing separate tax returns is not a major item. Most of our software prepares these returns with minimal effort. However, if you are farmer in a community property state, this likely will not help you. Community property taxpayers are required to report each other's income 50/50.