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A quirk in eligibility rules for a new unemployment tax break may lead some married couples to wonder whether they should file separate returns, even if they typically file jointly.
The short answer: Filing separately may make sense in some cases, especially when each spouse can get the maximum tax break. This strategy only applies for couples whose joint income is too high to get the break.
Even so, filing a joint return will likely still yield the greatest payoff for the bulk of families.
Households should use the route that offers the lowest total tax bill.
“For the most part, it makes sense to file jointly from a purely tax perspective,” said Oscar Vives Ortiz, a certified public accountant and financial planner based in Tampa. “The numbers are such that you get a little break.”
“But I always say run the numbers and see,” he added.
The American Rescue Plan waives federal tax on up to $10,200 of unemployment benefits collected last year.
The tax benefit applies per person – meaning a married couple can exclude a maximum $20,400 from income tax.
However, taxpayers can’t get the break if their modified adjusted gross income (excluding unemployment benefits) is $150,000 or more. The limit is the same regardless of filing status like single or married.
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The $150,000 limit would disqualify each spouse in a higher-earning couple – who both lost their jobs in 2020 and typically file a joint tax return – from getting the tax break.
Such couples, who likely fall in the 22% or 24% federal tax bracket, could be losing out on $4,500 to $5,000 in tax savings.
But filing separate returns could put each spouse under the $150,000 income limit and make each eligible.
However, there are caveats that could make a joint return more financially beneficial.
One large disincentive is that filing separate returns may disqualify couples from getting certain valuable tax credits and deductions, according to Lisa Greene-Lewis, a CPA at TurboTax.
The child and dependent care credit is worth up to $3,000 per for one qualifying individual and $6,000 for two or more. The deduction for interest paid on qualified student loans is worth up to $2,500.
The unemployment tax break would have to yield a larger financial benefit to make sense.
This would tend to be more likely for couples in which each spouse collected ample jobless benefits in 2020, according to tax experts. They would be getting a tax break on the maximum amount ($10,200 of benefits) or close to it.
This may apply to a fair number of couples. About 40 million people collected benefits last year and the average person got $14,000.
“If you’re not at the max level, run the numbers and see where you stand,” Ortiz said.
It may also make sense to file a separate return if one or both spouses had big medical expenses in 2020 and they itemize their tax return, he said.
“Sometimes in the case of medical bills, there’s a little game there to be played,” he said.
Taxpayers can deduct medical expenses incurred over the year, but only those costs that exceed 7.5% of their adjusted gross income.
Filing a separate return may make it easier to exceed that limit — and get a tax break for more medical costs.
For example, a taxpayer with $75,000 of income could get a tax deduction for any costs that breach $5,625. But a married couple with $150,000 of joint income can only start getting the tax break once medical costs exceed $11,250.
The IRS is allowing personal protective equipment to prevent the spread of Covid-19 (like masks, hand sanitizer and wipes) to count as a qualifying medical cost, the agency announced Friday.
If one spouse itemizes their tax return, the other must, as well (instead of taking the standard deduction).