It is not surprising to see married couples filing joint federal income tax returns as it results in a smaller tax bill than if the couple were to file two separate tax returns. However, things have just changed! For 2020, Congress put up some temporary but very significant tax-benefit provisions! These provisions may help put more money in your pocket. This blog will go over how filing separately may be a great money-saving strategy for the tax year of 2020 and how you can find out if it’s a strategy that’ll work for you.
For this year, four tax provisions will play a key role in whether you’re better off filing jointly or separately for the tax year of 2020. These provisions include:
- Tax-free unemployment
- Recovery rebate, round 1
- Recovery rebate, round 2
- Recovery rebate, round 3
Below, we’ll cover the rules for the four tax provisions and illustrate how it works while examining your tax return.
Tax-Free Unemployment
The American Rescue Plan Act of 2021 that was signed on March 11, 2021 excluded from tax the first $10.2k of 2020 unemployment benefits paid to an individual with 2020 modified adjusted gross incomes (MAGI) of less than $150k. Note that:
- This is per individual
- This is per return
- Once you reach $150k, you’ll lose the entire exclusion
[Note: MAGI is your adjusted gross income (AGI) found in line 11 of your Form 1040 minus any unemployment benefits you may have.]
Example: Danny has $12k of unemployment benefits and has $30k of W-2 income. He and Maria have $200k of MAGI. If Danny files as married, he’ll pay tax on the $12k. However, if he files as married, filing separately, Danny will not pay tax on the $10.2k.
Community Property
In a community property state, you usually split most tax items equally between the spouses. This could potentially make the separate return not advantageous. The nine community property states include:
- Arizona
- California
- Idaho
- Louisiana
- Nevada
- New México
- Texas
- Washington
- Wisconsin
Unemployment compensation is a community property, so on a married-filing-separately tax return, you’ll need to allocate it equally to each spouse.
Okay, so what if we don’t have any guidance on what to do with the $10.2k exclusion in a married filing separately tax return? We split the unemployment compensation, but what do we do after?
- Split the $10.2 k ($5.1k each)?
- Grant each spouse $10.2k?
- Enable the $10.2k against only the unemployment received?
Recovery Rebate Round 1
The recovery rebate, round 1, is a refundable tax credit on the 2020 tax return. It is equal to:
- $1.2k ($2.4k on a joint return), and
- $500 for each dependent under the age of 17
Your credit decreases by 5% of the amount your AGI exceeds:
- $150k (married/filing jointly)
- $112.5k (head of the household)
- $75k (single/filing separately)
If the IRS gives you an advancement of credit based on your 2018 or 2019 AGI and dependents. Now, if the IRS looks at your 2020 tax return, the following can happen:
- If your tax credit based on your 2020 tax return exceeds your advance payment, you get the additional amount as a refundable tax credit.
- If your actual credit is less than the advance payment, you get to keep the money. You will not have to pay back any excess received.
Recovery Rebate Round 2
This refundable tax credit on the 2020 tax return is equal to:
- $600 ($1.2k on joint returns), and
- $600 for each dependent under the age of 17
Your credit goes down by 5% of the amount your AGI exceeds
- $150k (married/filing jointly)
- $112.5k (head of the household)
- $75k (single/filing separately)
The IRS gave you an advance payment of this credit derived from your 2019 AGI and dependents. Now, the IRS looks at your 2020 tax return and gives you an additional amount as a refundable tax credit if your 2020 tax return exceeds the advance payment. It’s also advantageous when your actual credit score is less than the advance payment. You can keep the money and not have to pay back any excess received.
Recovery Rebate, Round 3
This is a refundable tax credit on the 2021 tax return, which is equal to:
- $1.4k ($2.8k on a joint return)
- $1.4k for each dependent, regardless of age
Your credit phases out over these AGI ranges:
- $150k to $160k (married/filing jointly)
- $112.5k to $120k (head of the household)
- $75k to $80k (single/filing separately)
The IRS will provide you with an advance payment on this credit on your 2019 or 2020 AGI and dependents. If your first advance payment used your 2019 return info, then the IRS will direct an additional payment based on your 2020 tax return if the IRS processes your 2020 return by the 15th of August, 2021.
You would then reconcile your advance payment(s) on your 2021 tax return:
- If your credit exceeds the advance payment, you can get the difference as a refundable credit.
- If your actual credit is less than the advance payment, you get to keep what you have. No need to pay back the excess benefit.
Why Separate Returns Could Be Better
There are two main reasons why separate returns might have net lower federal tax returns versus a joint return.
- If your MAGI is $150k or more on a joint return, but the spouse who earns under $150k receives unemployment compensation on a separate return, then the spouse can take the full exclusion of up to $10.2k (probable exception includes community property states).
- If one spouse has an AGI of $75,000 or less, but the joint AGI is over $150k, then that spouse can claim the dependents and get all the available round 1 and round 2 credits on the 2020 tax return, including the round 3 advancements.
On most occasions, married couples would pay less tax on a joint return versus two separate returns. However, on the 2020 returns, the COVID-19 temporary tax provisions can create a lower tax bill when married couples file separately. Just remember to consider the four tax provisions that’ll be determining factors for whether you’re better off filing jointly or separately. We hope this blog helped you see how filing separately can be a great money-saving strategy for the tax year of 2020. At MFI Works, we know these topics can be complicated, so don’t hesitate to contact us if you have any questions. To schedule a free initial business strategy session, click here.
