Married filing separately for student loans: is it worth it in Texas?

Filing separately can lower a payment on an income-driven student loan plan, because those plans look at the income on your return. In Texas, community property law changes what that return shows, and filing separately costs several credits outright.

Why anyone does this

Income-driven repayment sets a payment from the income reported to the loan program, so a return that shows one spouse's income rather than two can produce a smaller monthly figure. How much smaller is decided by the plan and the servicer rather than by the return, and this article covers only the tax half of the trade.

The Texas twist: half of everything

Texas is a community property state, and that changes the arithmetic in a way couples elsewhere never meet. Split the federal returns and neither one shows only its own earner. Each spouse picks up half of the community income, adds whatever income is separately theirs, and reports the total. A Form 8958 goes on each return to set out how that halving was arrived at. Which income counts as community and which as separate is generally settled by the law of the state where you are domiciled.

Follow that through and the strategy can turn on the borrower. Where the other spouse earns more, the borrower's separate return can end up showing more income than their own salary, not less, because half of the higher earner's pay lands on it.

What community income actually is

Three things generally make income community. Whatever the community property itself produces. Pay for work — salaries, wages and the rest of it — performed by either of you during the marriage, in the years your home was a community property state. And property that cannot be pinned down as separate. Texas then goes further than most of the other community property states, and Publication 555 is where you see it: in Texas, income from most separate property is community income too, so a spouse's own investment income is generally split between the two returns rather than staying with the spouse who owns the asset. Two exceptions are worth naming because they catch people out: individual retirement arrangements and Coverdell education savings accounts are separate property by law, so what comes out of them is separate income rather than something to halve.

What filing separately costs you

Publication 501 sets out the special rules that ride along with this status, and their combined effect is that a separate return usually costs more tax than any other status you qualify for. What goes:

• No deduction for student loan interest, and no education credits — not the American opportunity credit and not the lifetime learning credit. The student loan interest deduction and education credits describe what is being given up.
• No earned income credit, unless there is a qualifying child in the picture and the other requirements are met too.
• In most cases no credit for child and dependent care expenses, and a smaller slice of employer-provided dependent care benefits that you can keep out of income. Spouses who are legally separated, or who live apart, may still reach the credit.
• No adoption credit or exclusion, in most cases.
• A capital loss deduction limited to $1,500, half of what a joint return allows.
• The child tax credit, the credit for other dependents and the retirement savings contributions credit all start shrinking at income levels set at half of the joint ones.
• No standard deduction at all if your spouse itemizes, and a basic standard deduction of half the joint amount where you can take it.
• A tax rate that is generally higher than the one on a joint return.

The comparison to actually run

The method is not complicated, only tedious. Run the return twice, once jointly and once apart, and treat the gap between the two tax figures as the annual price of the lower payment. Then take both income figures to the servicer and ask what the payment would be on each. Until you have done both halves you are not comparing like with like.

What the answer turns on is the size of the gap between the two incomes and how many children are in the household. In Texas the community split narrows the very gap the strategy depends on, which is why the advice that works for a couple two states away can do nothing at all here.

When it still makes sense, and when to get help

Two situations make the separate return less of a choice. One is a spouse who will not share their financial information, which leaves no honest way to prepare a joint return. The other is a refund that keeps being taken to pay a debt that belongs to the other spouse, which has a remedy of its own through an injured spouse claim rather than through a change of status.

Beyond those, be honest about what a web page can settle. A couple with a wide income gap, a forgiveness program in play, or a business on one side of the marriage is past that point. An hour with a preparer willing to run the return both ways is the cheapest part of this decision, and it is the only version of the answer that uses your own numbers.