Married couples with student loans must make a difficult decision when they file their tax returns. They can choose to file jointly, which often leads to a lower tax bill. Or they can file separately, which may result in a higher tax bill, but smaller student loan payments. So which decision will save the most money?
First, let’s discuss the difference between the two filing statuses available to married couples.
Married filing jointly
Married couples always have the option to file jointly. In most cases, this filing status results in a lower tax bill. The IRS strongly encourages couples to file joint returns by extending several tax breaks to joint filers, including a larger standard deduction and higher income thresholds for certain taxes and deductions.
Married filing separately
Because married couples are not required to file jointly, they can choose to file separately, where each spouse is taxed separately on the income he or she earned. However, this filing status typically results in a higher tax rate and the loss of certain deductions and credits. However, if one or both of the spouses have student loans with income-based repayment plans, filing separately could be beneficial if it results in lower student loan payments.
For help figuring out which filing status is better for married couples with student loans, we reached out to Mark Kantrowitz, publisher and Vice President of Strategy at Cappex.com. Kantrowitz knows quite a bit about student loans and taxes. He’s testified before Congress and federal and state agencies on several occasions, including testimony before the Senate Banking Committee that led to the passage of the Ensuring Continued Access to Student Loans Act of 2008. He’s also written 11 books, including four bestsellers about scholarships, the FAFSA, and student financial aid.
Two Advantages to Filing Taxes Jointly:
- Most education benefits are available only if married taxpayers file a joint return. This can affect the American opportunity tax credit, the lifetime learning credit, the tuition and fees deduction (which Congress let expire as of January 1, 2017, but is still available for 2016 returns), and the student loan interest deduction.
- Couples taking the maximum student loan interest deduction of $2,500 in a 25% tax bracket would save $625 in taxes. But this “above the line” deduction also reduces Adjusted Gross Income (AGI), which could yield additional tax benefits (e.g., greater benefits for deductions that are phased out based on AGI, lower thresholds for certain itemized deductions such as medical expenses, and miscellaneous itemized deductions).
However, there is a potential downside to filing jointly for couples with student loans.
Income-driven repayment plans use your income to determine your minimum monthly payment. Generally, your payment amount under an income-based repayment plan is a percentage of your discretionary income (the difference between your AGI and 150% of the poverty guideline amount for your state of residence and family size, divided by 12).
- If you are a new borrower on or after July 1, 2014, payments are generally limited to 10% of your discretionary income but never more than the 10-year Standard Repayment Plan amount.
- If you are not a new borrower on or after July 1, 2014, payments are generally limited to 15% of your discretionary income, but never more than the 10-year Standard Repayment Plan amount.
Because filing jointly will increase your discretionary income if your spouse is also earning money, your required student loan payment will typically increase as well. In some cases, the difference is negligible; in others, this can add up to a pretty significant cost difference.
“Calculating the trade-offs of income-driven repayment plans versus the student loan interest deduction and other benefits is challenging,” Kantrowitz says, “in part because the monthly payment under income-driven repayment depends on the borrower’s future income trajectory and inflation, not just the inclusion/exclusion of spousal income.”
Fortunately, some tools can help you run the numbers.
An example: Meet Joe and Sally
Here’s a simple scenario that shows how a change in filing status can save on taxes but cost more on student loans:
- Joe and Sally are married with no children.
- They live in Florida (no state income tax).
- Joe is making $35,000 per year and has $15,000 of student loan debt with a 6.8% interest rate.
- Sally is making $75,000 per year and has $60,000 of student loan debt with a 6.8% interest rate.
First, we can estimate Joe and Sally’s tax liability for filing jointly versus separately. TurboTax’s TaxCaster tool makes this pretty easy. Here’s what we get when run their numbers using 2016 tax rates:
- Filing jointly, Joe and Sally would owe $13,249 in federal taxes.
- Filing separately, they would owe $15,178.
So they would save just over $1,900 in federal taxes by filing jointly. But how would filing jointly affect their student loan payments?
We can use a student loan repayment estimator like the one provided by the office of Federal Student Aid to find out. Here’s what we get when we run the numbers and choose the Income-Based Repayment option, assuming they are new borrowers on or after July 1, 2014:
- Filing jointly, Joe’s minimum required monthly student loan payment under a standard repayment plan would be $143, and Sally’s would be $571, for a total of $714 per month.
- Filing separately, Joe’s minimum required monthly student loan payment would be $141, and Sally’s would be $474, for a total of $615 per month.
Over the course of a year, Joe and Sally would only save $1,188 on their student loan payments by filing separately. Even with the additional loan payments they would have to make, filing jointly would save them $712 more than filing separately.
What’s best for your situation?
Every situation is different. The simple example above comes out in favor of filing jointly, but you will need to run your own numbers to figure out what is right for you. Here are additional tips to help you figure it out:
- Know how much you owe. Make a list of all loan balances, interest rates, and the type of each student loan you have. You can find your federal student loans on the National Student Loan Data System. You can find information on your private student loans by looking at a recent statement.
- Estimate your student loan payment options. Using a student loan repayment estimator like the one mentioned above, determine your required payments when filing separately versus jointly.
- Calculate your tax liability. Use a tool like TurboTax’s TaxCaster or 1040.com’s Free Tax Calculator to calculate your federal and state tax liability when filing separately versus jointly.
- Be aware of long-term consequences. Filing separately might result in lower monthly payments today but more interest paid over time. If you make it to the 20- or 25-year forgiveness point, that could have tax implications down the line. Kantrowitz points out that “forgiveness is taxable under current law, causing a smaller tax debt to substitute for education debt. The main exception is borrowers who will qualify for public student loan forgiveness, which occurs after 10 years and is tax-free under current law.” Keep those long-term consequences in mind as you make a decision.
- Consider steps to lower your AGI. Your eligibility for income-driven student loan repayment plans depends on your AGI, which is essentially your total income minus certain deductions. You can reduce this number, and potentially lower both your tax bill and your required student loan payment, by doing things like contributing to a 401(k), IRA, or Health Savings Account.
- Keep the big picture in mind. These decisions are just one part of your overall financial situation. Keep your eyes on your big long-term goals and make your decision based on what helps you reach those goals fastest.
Other unique situations
There are a few unique situations that make deciding whether to file jointly or separately a little more complicated. Do any of these situations apply to you?
Divorce and legal separation
Sometimes, determining marital status to file tax returns isn’t cut and dried. What happens when you and your spouse are separated or going through a divorce at year end? In this case, your filing status depends on your marital status on the last day of the tax year.
You are considered married if you are separated but haven’t obtained a final decree of divorce or separate maintenance agreement by the last day of the tax year. In this case, you can choose to file married filing jointly or married filing separately.
You and your spouse are considered unmarried for the entire year if you obtained a final decree of divorce or are legally separated under a separate maintenance agreement by the last day of the tax year. You must follow your state tax law to determine if you are divorced or legally separated. In this case, your filing status would be single or head of household.
Pay as You Earn repayment plans
Pay as You Earn (PAYE) is a repayment plan with monthly payments that are limited to 10% of your discretionary income. To qualify and to continue to make income-based payments under this plan, you must have a partial financial hardship and have borrowed your first federal student loan after October 1, 2007. Kantrowitz says the PAYE plan bases repayment on the combined income of married couples, regardless of tax filing status.
Unpaid taxes, child support, or defaulted federal student loans
If you or your spouse have unpaid back taxes, child support, or defaulted federal student loans, joint income tax refunds may be diverted to pay for those items through the Treasury Offset Program. “Spouses can appeal to retain their share of the federal income tax refund,” Kantrowitz says, “but it is simpler if they file separate returns.”