As the April 15, 2016 deadline for filing your 2015 taxes draws near, it is time to collect your W-2s, 1099s, and expense receipts and think about filing your returns. Because military families face some unique situations and rules, here are some considerations for your filing status for your return(s).
1. Federal Filing Status
The first step when filing a return is determining the correct filing status –single, married filing separately, married filing jointly, or head of household – for your federal income tax return. If you and your spouse were married as of December 31, 2015, you can choose to file married filing jointly, reporting all of your income and expenses together on one return, or married filing separately, each reporting your income and expenses on a separate return.
For your federal return, married filing jointly usually results in a larger tax refund, because if you file separately your tax rate is higher and you are limited in the number and type of credits and deductions you can claim. For example, a spouse filing separately has to file either standard deduction or itemized deduction same as the other spouse even if the other method is more beneficial, cannot claim education benefits or the Earned Income Credit (EIC), and usually cannot claim the Child and Dependent Care Credit or the Adoption Credit.
There are some factors that would lead to a better outcome if you file married filing separately. A consideration for each spouse is protecting yourself legally and financially. If you suspect that your spouse may lie on his or her tax return, or your spouse does not want to file as required by law, by filing separately you protect yourself from being held liable for his or her back taxes, fines, penalties, and interest. Additionally, if your spouse owes debts in the form of child support, delinquent student loan payments, or back taxes, these can be taken from a joint tax refund, but you protect your own refund by filing separately even though you cannot prevent the spouse’s refund from being reduced or taken completely.
There are also certain situations where filing separately could lead to a larger tax refund overall. If you have a lot of itemized deductions that are subject to an Adjusted Gross Income or “AGI” “floor” (Line 37 on your Form 1040- Total income minus certain expenses, before your standard or itemized deduction is taken), it may be more beneficial to file two separate returns. For example, you can only deduct medical expenses that exceed 7.5% of AGI, so you can deduct more medical expenses if by filing separately you would have a lower AGI. If you have a lot of unreimbursed medical expenses this may result in a larger tax refund. Other such expenses limited by AGI include investment expenses and employee business expenses. This outcome depends on the situation, so be sure to consider any such expenses and your combined AGI vs. your separate AGI.
Before making your choice for your federal filing status, be sure to do your research and/or discuss with your tax preparer or a tax professional, a CPA, enrolled agent, or attorney, to determine which is the best choice financially and legally. The considerations set forth here should not be considered legal advice!
2. Active Duty Military State Filing Status
Once a married couple has decided on filing separately or jointly for federal tax purposes, the general rule is that you choose the same filing status for state purposes if you have to file a state income tax return. Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming do not have a personal income tax, while New Hampshire and Tennessee tax only dividend and interest income (and not wage income).
For those states that do require a personal income tax return, there are special rules for active duty military. That is because active duty service members can keep their state of residency (usually their Home of Record), the state in which they are required to file a tax return, for tax purposes even when they move for military orders. Since active duty spouses can keep a residency despite moving, that can prevent them from having to file a return in the state of their duty station, instead filing in the state of residency. This can be advantageous if the state of residency has a lower personal income tax rate, or no income tax rate, compared to the personal income tax rate of the state of duty station.
3. Military Spouse Residency Relief Act (MSRRA)
What about married active duty spouses? How does this “keeping the state of residency rule” apply to his or her spouse? Before 2009 it had no affect, but in 2009 Congress passed the Military Spouse Residency Relief Act (MSRRA), which allows the nonmilitary spouse to keep the same residency state as the active duty military spouse if the requirements are met. The exact rules vary by state, but at minimum the nonmilitary spouse must have lived in the state of residence and claimed the state as a residence for MSRRA. The nonmilitary spouse cannot merely adopt the state of residency by virtue of marriage to the active duty military, but instead must have lived in the state and also established residence by registering to vote, getting a state driver’s license, and other residency requirements under that state’s law. The nonmilitary spouse generally must also be in the new state for the purpose of living with the active duty military spouse.
So for a nonmilitary spouse who has become a resident of the active duty military spouse’s state of residence, MSRRA can apply and they can both retain the same state of residence even after moving under military orders. This is ideal if your state of residence does not have a state personal income tax or has a lower personal income tax rate than the state of your duty station. Always make sure to research your particular state’s rules to confirm that MSRRA applies.
4. If MSRRA Does Not Apply
If MSRRA does not apply there may still be a way to reduce your tax bill using the active duty spouse’s state of residence. Because of the rule allowing the active duty military spouse to keep his or her state of residence, states with personal income taxes have exceptions specifically allowing a married couple where one spouse is active duty to file married filing separately, even if they would normally have to file jointly. States usually require a married couple filing jointly to use the same filing status for state purposes, and this exception can lead to tax savings.
If the state in which you file married filing separately is a community property state (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, or Wisconsin are community property states), there are specific rules about how you divide up income and expenses for married filing separately purposes. Since you have to figure the calculation instead of just reporting your own income and expenses, this adds some extra complexity to filing separately in these states.
For example, my husband, who was born and raised in Washington, was stationed in California for 2015. I am from California and met my husband here, having never lived in Washington. Since I did not live in Washington and establish residence, I cannot use the benefits of the MSRRA. As a California resident I have to file a California tax return. My husband can keep Washington as his state of residence as long as he remains active duty military. According to Franchise Tax Board (FTB) Publication 1051A, I can choose to file my California state tax return as married filing separately because my husband is active duty military. Since my husband does not have to pay a state income tax in Washington, if I choose this route only my income would be taxed by my state, California.
As a community property state, California has rules requiring me to split up our income and expenses 50/50; I have to take the total income and expenses from our Federal Form 1040 and allocate myself half, excluding expenses that I cannot deduct on a married filing separately return such as education expenses. Although my tax rate is higher and the standard deductions and exemptions are lower than if I filed jointly, this could still result in a larger tax refund, since only half of our total income will be taxed by California, instead of all of our income.
If MSRRA does not apply to you, but you are in a similar situation where the active duty military spouse’s state of residence has a lower personal income tax rate than the nonmilitary spouse’s state of residence, this could be an option to maximize your state tax refund.
When filing returns, military married couples must carefully consider first filing status for their federal returns. Although married filing jointly generally provides the highest tax refund, you must consider certain deduction situations and each spouse should consider protecting himself or herself legally and financially to determine the best filing status.
Once you have determined your federal filing status, families must then consider state filing status if applicable. Active duty military members can use their Home of Record as their state of residence, choosing to continue to file a state tax return (or not file) in that state instead of their current duty station. If the spouse falls under the provisions of the MSRRA, by having lived in the same state as the Home of Record and established it as a state of residence, he or she can also keep the same state of residence. Generally you will use the same filing status for state as you do for your federal return.
If the MSRRA does not apply, there can still be a way to lower your tax bill. If you file jointly federally you can consider filing separately for state purposes, if the state of residence of the active duty spouse has a lower income tax rate than the nonmilitary spouse’s state of residence. You should then do the necessary computations, comparing filing jointly versus separately, to determine which will result in an overall higher tax refund.
When in doubt, please do your research or ask for help! The Internal Revenue Service (IRS) website (irs.gov) and the website for your state’s Department of Revenue are good starting points. For example, the website for the California FTB’s website (ftb.ca.gov) has instructions, publications, and a number of other resources. The instructions for Form 1040 and your state’s equivalent also have a lot of useful information. Talk to your tax preparer/tax attorney/CPA, or call the IRS or state with questions. If you file on your own using a service like TurboTax or H&R Block, they usually have experts that you can ask for advice on the phone and/or online. Military OneSource offers free financial counseling, tax consultations, and secure online tax preparation and filing. You can also consider the IRS’ Volunteer Income Tax Assistance (VITA) Program, which helps low-income families with tax preparation assistance, if you fall within the income limits. The volunteers are certified tax preparers and may be able to help or point you in the right direction.
Although filing your taxes is considered a pain, with some research and by asking the right questions you can determine the best filing status for your federal and state returns and maximize your refund.