'Married Filing Separately' Can Lower Wealthy Clients' Taxes

A little-used status for filing taxes may benefit some of your wealthy clients under the tax reform legislation passed by Congress late last year.

The Married Filing Separately (MFS) filing status can often limit tax breaks, but the reform package’s new deduction for pass-through businesses can lower tax bills for some couples if they opt to file separately.

In many other circumstances MFS takes away as much as it might give, but examining the status—many tax preparers will run an analysis of MFS versus Married Filing Jointly—makes sense for some wealthy clients through the rest of this year, advisors said.

“Many clients won’t learn until next filing season that there may be advantages to filing separately because of the qualified business income deduction,” said CPA Brett Bissonnette, a tax manager in the Dayton, Ohio, office of Clark Schaefer Hackett. “Forward-looking clients will begin to plan for their filing status when projections are done in November and December.”

A sometimes confusing new provision in the tax code, the Qualified Business Income Deduction in Section 199A, allows some taxpayers to deduct 20 percent of income they receive from such businesses as partnerships, LLCs, subchapter S corporations and sole proprietorships that pass through net income to owners.

Each situation for a 199A deduction needs a close look before changing filing status. “It might appear to be advantageous to file MFS to lower your taxable income, especially for those over the (Section 199A) threshold,” said Timothy Brennan, a CPA and tax manager at Bederson CPAs and Advisors in Fairfield, N.J.

Limits to the full 20 percent deduction kick in above $157,500 of taxable income for MFS and single filers and $315,000 for married couples filing jointly. The new standard deduction for a spouse using MFS status is the same as those using single status: $12,000.

“Clients think you can just split their income and the lower tax rates will be better than the joint tax rates. The reality is that the tax rates for separate filers put both of them in higher tax rates than a joint return,” said Scott Kadrlik, a CPA with Meuwissen, Flygare, Kadrlik & Associates in Eden Prairie, Minn.

“Where the spouses’ marginal taxable income is taxed in different brackets, an overall tax increase may result from filing separately,” Bissonnette added.

For 2015 (the latest year for which IRS statistics are available), only about three million of the some 150 million individual income tax returns were filed under the MFS status.

Married taxpayers who file jointly incur joint liability for all taxes due for the return year; MFS taxpayers do not. For couples with spouses in high-risk audit areas, for instance, audit adjustments flow through only to the spouse who operates the business, leaving the MFS-designated separate spouse without liability, according to Bissonnette.