Wow! Married, Filing Separately, May Be the Tax Year 2020 Strategy

If you are married, most likely you’ve always filed a joint tax return with your spouse.

Most of the time, a joint return shows less overall tax than two separate tax returns, because the married-filing-separately status has many tax disadvantages.

But fast-forward to the 2020 tax filing season — and nothing is as it was.

On the 2020 tax table, you find tax-free unemployment benefits and three rounds of recovery rebates. And you might find more cash by simply using the married-filing-separately option.

Surprised? Good! Read the article to see how these specific tax provisions work in the married-filing-jointly versus married-filing-separately 2020 tax returns.

Key Tax Benefits for 2020 Returns

This year, four tax provisions will be key to determining whether you’ll better be off filing a joint tax return or separate tax returns for the tax year 2020:

  • Tax-free unemployment
  • Recovery rebate, round 1
  • Recovery rebate, round 2
  • Recovery rebate, round 3

We’re going to walk through the rules for the four tax provisions and then show you how this works when examining your tax return.

Tax-Free Unemployment

The American Rescue Plan Act of 2021, which was signed into law on March 11, 2021, excludes from tax the first $10,200 of 2020 unemployment benefits paid to an individual with 2020 modified adjusted gross income (MAGI) of less than $150,000.

  • Note that this is per individual.
  • Note also that this is per return.
  • Then note that once you hit $150,000, you lose the entire exclusion.

Your MAGI is your adjusted gross income (AGI) from line 11 of your Form 1040 minus any unemployment benefits.

Example. John has $12,000 of unemployment and $30,000 of W-2 income. He and Sally have $200,000 of MAGI. If John files as married, he pays tax on the $12,000. If John files as married, filing separately, John pays no tax on $10,200.

Community Property

In a community property state, you generally split most tax items equally between the two spouses, potentially making the separate-return strategy not advantageous.

The nine community property states are:

  1. Arizona
  2. California
  3. Idaho
  4. Louisiana
  5. Nevada
  6. New Mexico
  7. Texas
  8. Washington
  9. Wisconsin

Unemployment compensation is community property, and on a married-filing-separately tax return, you need to allocate it equally to each spouse.

But now we find a fly in the ointment: we don’t have any guidance on what to do with the $10,200 exclusion in a married-filing-separately tax return. Remember, we split the unemployment compensation, but then what do we do?

  • Split the $10,200 ($5,100 each)?
  • Grant each spouse $10,200?
  • Allow the $10,200 against only the unemployment received?

Recovery Rebate, Round 1

The recovery rebate, round 1, is a refundable tax credit on the 2020 tax return, equal to

  • $1,200 ($2,400 on a joint return), plus
  • $500 for each dependent under age 17.

Your credit decreases by 5 percent of the amount of your AGI exceeds

  • $150,000 if married, filing a joint return;
  • $112,500 if the head of household; or
  • $75,000 if single or if married, filing separately.

The IRS gave you an advance payment of this credit based on either your 2018 or 2019 AGI and your dependents. And now the IRS looks at your 2020 tax return and does the following:

  • Smiles on you if the tax credit based on your 2020 tax return exceeds the advance payment. What do we mean by “smiles on you”? You get the additional amount as a refundable tax credit.
  • Smiles on you (again!) if your actual credit is less than the advance payment. You keep the money. You don’t have to pay back any excess received.

Recovery Rebate, Round 2

This is a refundable tax credit on the 2020 tax return, equal to

  • $600 ($1,200 on a joint return), plus
  • $600 for each dependent under age 17.

Your credit decreases by 5 percent of the amount of your AGI exceeds

  • $150,000 if married, filing jointly;
  • $112,500 if the head of household; or
  • $75,000 if single or if married, filing separately.

The IRS gave you an advance payment of this credit based on your 2019 AGI and your dependents. And now the IRS looks at your 2020 tax return and

  • Smiles on you if the tax credit based on your 2020 tax return exceeds the advance payment. What do we mean by “smiles on you”? Once again, you get the additional amount as a refundable tax credit.
  • Smiles on you (again!) if your actual credit is less than the advance payment. You keep the money. You don’t have to pay back any excess received.

Recovery Rebate, Round 3

This is a refundable tax credit on the 2021 tax return, equal to

  • $1,400 ($2,800 on a joint return), plus
  • $1,400 for each dependent, regardless of age.

Your credit phases out over the following AGI ranges:

  • $150,000 to $160,000 if married, filing jointly;
  • $112,500 to $120,000 if the head of household; or
  • $75,000 to $80,000 if single or if married, filing separately.

The IRS will give you an advance payment of this credit based on your 2019 or 2020 AGI and your dependents. If your first advance payment used your 2019 return information, then the IRS will send an additional payment based on your 2020 tax return if the IRS processes your 2020 tax return by August 15, 2021.

You then reconcile your advance payment(s) on your 2021 tax return:

  • If your actual credit amount exceeds the advance payment, you get the difference as a refundable credit.
  • If your actual credit is less than the advance payment, you keep what you have. You don’t have to pay back the excess benefit.

Why Separate Returns Could be Better

There are two main reasons you may have net lower federal tax with separate returns versus a joint return.

First, if your MAGI is $150,000 or more on a joint return, but the spouse who received the unemployment compensation earns under $150,000 on a separate return, then the spouse can take the full exclusion up to $10,200 (except possibly in a community property state).

Second, if one spouse has AGI of $75,000 or less, but your joint AGI is over $150,000, then that spouse can claim the dependents and get all the available round 1 and round 2 credits on the 2020 tax return as well as the round 3 advance payment.

When considering the above, keep two important notes in mind:

  1. For a couple that got joint advance payment(s), the law says you allocate 50 percent of the payment to each spouse. The higher-earning spouse doesn’t pay back any of his or her allocated advance payment, while the lower-income spouse will get the difference as a refundable tax credit.
  2. Married taxpayers who agree on how to allocate dependents on separate returns do not have to use the “tiebreaker” rules and can choose who claims which dependents.

Important note. You may lose other deductions and credits on a separate return. The only way to know which is better in light of these temporary provisions is to run your tax returns both ways and see which puts you ahead. You also need to consider other non-tax-return items, such as the loss of the health insurance premium tax credit or changes in your Medicare premiums.

Example: Background Information

Robert and Lisa are married with a 2-year-old son and live in Florida. Their 2019 tax return showed AGI of $190,000. During tax year 2020, their income decreased to $175,000:

  • Wages of Robert: $110,000
  • Wages for Lisa: $50,000
  • Unemployment for Lisa: $15,000

Robert and Lisa both got the following round 1 and round 2 economic impact payments based on their 2019 tax return:

  • Round 1 – $900
  • Round 2 – $0

Example: 202 Joint Return

If Robert and Lisa file a joint return, here’s the result:

Tax Year 2020 Married Filing Jointly
Wages  $        160,000
Unemployment  $          15,000
AGI  $        175,000
Standard Deduction  $        (24,800)
Taxable Income  $        150,200
Tax before Credits  $          24,624
Child Tax Credit  $          (2,000)
Tax after Credits  $          22,624
2020 Recovery Rebate Credit – Round 1  $              (750)
2020 Recovery Rebate Credit – Round 2  $              (550)
Net Federal Tax  $          21,324

Example: 2020 Separate Returns

Tax Year 2020 MFS: Robert MFS: Lisa
Wages  $     110,000  $    50,000
Unemployment  $                –  $      4,800
AGI  $     110,000  $    54,800
Standard Deduction  $     (12,400)  $  (12,400)
Taxable Income  $       97,600  $    82,600
Tax before Credits  $       17,510  $      5,124
Child Tax Credit  $                –  $    (2,000)
Tax after Credits  $       17,510  $      3,124
2020 Recovery Rebate Credit – Round 1  $                –  $    (1,250)
2020 Recovery Rebate Credit – Round 2  $                –  $    (1,200)
Tax after Credits  $       17,510  $          674
Total Both Returns  $                              18,184

Comparison

For tax year 2020, filing two separate tax returns saves Robert and Lisa $3,140 versus a joint return:

  • $21,324 total tax on a joint return, less
  • $18,184 total tax on two separate returns.

Example: 2021 Economic Impact Payments

If Robert and Lisa file a joint 2020 tax return, they would get no advance payments of the 2021 recovery rebates since Robert and Lisa’s joint AGI is over $160,000 in both 2019 and 2020.

But if Robert and Lisa file separate 2020 tax returns, then Lisa will receive a $2,800 economic impact payment because her AGI is under $75,000.

By locking in this payment now, they guarantee they receive the cash — they may not be able to claim any of the credit on their 2021 tax return depending on their income.

Already Filed? It’s Not Too Late

Did you already file a joint tax return, but now you realize you’d save federal tax with separate returns?

Not to worry! It’s not too late to change your mind, but don’t procrastinate — if you file a superseding tax return prior to the unextended due date (May 17, 2021), then you can do your unjoint election.

You’d need to file a superseding tax return on Form 1040 or Form 1040x. When you mail the return — which you’d need to do since you cannot electronically file a Form 1040X amended return with a filing status change — be sure to write “SUPERSEDING RETURN” in red at the top of page 1.

Takeaways

In most circumstances, a married couple would pay less tax on a joint return versus two separate returns.

But on your 2020 returns, the COVID-19 temporary tax provisions could create lower tax bills when a married couple files separate returns. Of course, choosing the married-filing-separately option can cause the loss of some deductions and credits and can create new ones, as explained in this article.

What to do?

Make sure to compare the married-filing-jointly option with the cash-back results achieved by filing separately.

And remember to consider the four tax provisions that’ll be key to determining whether you’ll be better off filing a joint tax return or separate tax returns for tax year 2020:

  • Tax-free unemployment
  • Recovery rebate, round 1
  • Recovery rebate, round 2
  • Recovery rebate, round 3

If you think your joint AGI for tax year 2021 will be over $160,000, then it’ll be essential to get an advance payment of the 2021 recovery rebate; otherwise, you’ll get zilch on your 2021 tax return. To obtain the advance payment, file your 2020 tax return on or before August 15, 2021.

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