When Does It Make Sense for Married Couples to File Taxes Separately?

Nobody likes filing taxes every spring.  It takes a lot of time to receive all of your paperwork, and even more time to calculate and review to figure out whether you’re due money back.  And let’s face it- it’s not exactly exciting stuff.

But when you get married, this process can get even more complicated.  In addition to having double the amount of information to review, you need to decide the best way to file your taxes with your spouse.

Married couples have two options when it comes to filing their taxes- to file jointly with their spouse, or to file separately.  As the name implies, filing jointly with your spouse means that income and deductions for both you and your spouse are reported on one tax return.  When you file separately, each of you files a separate tax return with just your personal information on your own return.

But which option is the right one to choose?

Most Couples Choose to File Jointly

As with most tax-related questions, the answer to this question will vary depending on your personal situation.  But, the better option for most couples is to file jointly. There are several reasons for this:

  • Married couples who file separately hit higher tax rates at lower income levels. So, your effective tax rate between you and your spouse is typically higher for couples who file separately rather than jointly
  • The standard deduction is lower for couples who file separately, and many itemized deductions are reduced or completely eliminated if you file separately rather than jointly.
  • There are more tax breaks and credits available for joint filers, such as the Earned Income Tax Credit

So, this should be a fairly easy decision for most couples.  However, there are a few key situations where it makes sense to file separately from your spouse.  I highly recommend either calculating your taxes due both filing jointly or separately, or seek the assistance of a CPA, if you have doubts as to which would be best for you.

When Would It Make Sense to File Separately?

This is not an exhaustive list, but there are a few key scenarios where it may make sense to file separately from your spouse

You are on an student loan income-driven repayment plan. If your student loans are on an income-driven repayment plan, the amount you pay per month is tied to your annual income.  Whether or not your annual income is just your personal income, or includes your spouses as well, depends on whether you file jointly or separately.

So, if you have a significant loan balance and are on one of these payment plans, if you file separately, you can base your payments on your income alone.  But, as soon as you file your taxes jointly with your spouse, your spouses income will be included the calculation used to determine your loan payments.

You still may be better off filing jointly and paying the extra amount per month toward your student loans, but you should definitely keep these consequences in mind while making your decision.

I talk about this in my free eBook, “13 Steps to Take Before Making Your Next Student Loan Payment”.  Subscribe to my newsletter, and I’ll send you a copy for free!

Either You or Your Spouse Has Significant Medical Expenses

The current tax code allows you to deduct any medical expenses that are over 10% of the income reported on your tax returns.  This income number includes your spouse’s if you file jointly, but doesn’t if you file separately.  So, if you had high medical expenses this year, you may end up paying less taxes by filing separately, depending on the numbers on the rest of your return.

For example, say that your annual salary is $75,000, and your spouse’s annual salary is $125,000.  And, let’s say that you had a medical issue last year that cost you $10,000 total.

If you file jointly, your total income reported on your tax return would be $200,000.  Since your total medical expenses ($10,000) is less than 10% of your income ($200,000), you wouldn’t be able to deduct any of these expenses.

But, if you file separately, your income on your tax return is only $75,000.  Since you spend over 10% of this on medical expenses, you would qualify for this deduction.

You and Your Spouse Have (Very) Different Salaries

If you earn significantly more than your spouse (or vice versa) it may work in your favor to calculate each of your tax burdens separately rather than combining your incomes.  If you also have a lot of investment income, such as capital gains or dividends, this scenario applies even more.

Again, in this case, I’d recommend you calculate your tax burdens both ways- jointly and separately- and compare the total taxes due in order to decide.  But if, for example, you make $250,000 a year and your spouse makes $30,000, I wouldn’t recommend automatically filing jointly.  Take the time to calculate your total tax bill by filing separately as well, and choose which one works out best for you.

Your Spouse Has Tax Debt 

If your spouse hasn’t paid their taxes in the past, the second that you file jointly, this becomes your debt, too.  If you file separately, you won’t be held legally responsible for this debt.  This is still not a good situation for your family, of course, but filing separately can give you some legal protection in the event of an audit.

Generally speaking, if you have concerns about your spouse’s financial situation, maintaining some degree of legal separation with your money might not be a bad idea while helping them to work through it.  This certainly would include filing taxes as well, even if it means you pay a bit more.

Seek Help

Particularly if you think that any of the above scenarios apply to you, I don’t recommend doing this on your own.  Either use a self-guided program like TurboTax, or seek the help of a CPA, to review your specific circumstances and analyze your potential tax burden both if you file jointly or separately.

It’s no fun, and it adds a layer of work, but there’s too much money on the table to not do your due diligence.

If you have further questions or want to talk about any of the above ideas, don’t be afraid to reach out.  I don’t prepare tax returns, but I can help you find someone that I trust to review your situation and get you the answers you need.

 

Are Health Savings Accounts A Good Deal?

Health insurance is back in the news again. While the American Health Care Act proposed by Congressional Republicans probably faces serious legislative hurdles, it seems likely that health care is in for some major changes over the coming years.

As usual, the politics of the issue are outside the scope of this blog.  Instead, I want to take a closer look at Health Savings Accounts (HSAs), which Obamacare made much more commonplace.  And, any Republican change to the law is likely to increase the prevalence of HSAs going forward.

What is a Health Savings Account?

Health Savings Accounts are savings and investments accounts designed to pay for medical expenses.  Sometimes, employers may choose to make contributions for you as they would in your 401(k).  But more commonly, it’s on you to actively contribute to these accounts.

In order to qualify for an HSA, you need to be enrolled in a High Deductible Health Plan.  These plans have lower premiums, but require you to pay a higher amount of your health expenses than a traditional plan. A discussion of the different types of health care plans probably warrants an entire separate article, but you should confirm you are in a High Deductible Health Plan before attempting to open an HSA.

Using an HSA, you will save each month and use that money to pay for your health care costs, up to your annual limit, when you get sick.

One other important qualification note: in order to have an HSA, you can’t be listed as a dependent on someone else’s tax return.  In other words, if you are living with your parents house or someone else provides you with financial support, you may need to confirm with them whether or not they claim you as a dependent.

How Do Health Savings Accounts Work?

You can set up your direct deposit to contribute a portion of your income directly into your HSA. But, there’s a maximum for how much you can contribute annually.  If you’re single, you can contribute up to $3,400 in 2017.  If you’re married, the contribution limit is $6,750 per family.

Once the money is in your account, you can either keep it as cash, or invest the money in the stock market.  Investing this money is great if you’re planning on using your HSA to cover healthcare expenses in your retirement.  But, if you’re looking for a way to save for short term medical expenses, it’s best to keep your account in cash.  The more risk you take with the money in your HSA, the higher the likelihood that your account could go down in value.

A common misconception about HSAs has to do with how long you can use the money you contribute.  I often hear people cite rumors that you have to use the money you put into an HSA by the end of the year, or it expires.  Simply put, this is not true.  Money you contribute this year carries forward to the following year, and so on.  This can make HSAs a great vehicle to save for your healthcare expenses in the future, even if you’re perfectly healthy today.

And, when you change jobs, you still have access to the account.  Just like a 401(k), when you leave you can either keep your account with your old employer and spend it as needed, or you can open a separate HSA and transfer the money.

But why not just keep your money in a regular savings account?  What’s the purpose of having a separate health care savings account at all? Aside from the fact I typically recommend you have separate savings accounts for each of your savings goals, there’s one key benefit to HSAs that we haven’t addressed yet…

HSAs Come With Big Time Tax Benefits

Simply put, HSAs are one of the most tax efficient savings vehicle out there.  What they lack in flexibility (i.e., you need to use the money in the account on healthcare expenses), they make up for in tax benefits.

Money you contribute to an HSA isn’t taxed when you contribute it.  In other words, every dollar you put into your HSA (up to the annual limit) directly decreases your taxable income for the year.  In this way, these accounts work in a similar way to your 401(k).

But, that’s just the beginning.  Not only are the contributions not taxed, but neither the growth of the investments in your account or your withdrawals are taxed. The only catch is that there’s a tax penalty if you don’t use the money you withdraw on medical expenses.

To recap: money contributed to an HSA isn’t taxed when it goes into the account.  Growth isn’t taxed.  And withdrawals aren’t taxed (if spent appropriately).

Simply put, saving in an HSA is one of the best tax incentives out there.

A New Way To Save For Retirement

One of the most common questions I get from millennials has to do with how to appropriately account for health care expenses when they save for retirement.  With the future of Medicare and Social Security in doubt, our generation needs to do a better job saving for these types of expenses than our parents or grandparents did.

An HSA can be a fantastic way to save for these type of expenses.  If you are relatively healthy now and have low medical costs, consider using your HSA as a retirement savings vehicle to cover your medical costs as you get older.

In other words, treat your HSA the same way you treat your 401(k).  Regularly contribute money each month, and invest that money in a portfolio that aligns with your tolerance for risk and long term growth objectives.  As you get older, shift the investments into a more conservative portfolio.  If you do this correctly, by the time you retire, you’ll have a great source of money to cover retirement medical costs.

But, There’s a Catch

The strategy above is a great one, but only for specific people.  If you are relatively healthy now, HSAs can be a great way to save for retirement expenses.  But, if you have a lot of medical expenses now, this probably isn’t the right strategy for you.

The problem with HSAs for people who have high medical costs goes back to the beginning of this article- in order to have an HSA, you need to have a High Deductible Health Plan.  These plans can sometimes require that you pay $10,000 or more of your medical costs per year before your insurance kicks in to cover your expenses.  If you’re likely to spend a lot on heath care, it might be better for you to opt for a lower deductible health plan and skip the HSA altogether.  Or alternatively, to use the money in your HSA for your current medical expenses, rather than saving it for the future.

In other words, I think HSAs are a great option for most people, but if you have a lot of medical expenses, it may not be the best one for you.  If you’re in this boat, I recommend sitting down and comparing the tradeoff between paying a higher premium for more comprehensive health insurance vs. paying a lower premium with a higher deductible.  Let this analysis drive your decision.

I help my clients make these decisions all the time.  If you need help, give me a call.

Should You Buy Snapchat Stock?

No.

No, you shouldn’t.

Unlike a lot of financial planners out there, I love to invest in individual stocks.  I typically include some individual stocks in a portion of my clients’ portfolios, in addition to widely diversified, low-cost ETFs or index funds.

But that being said, you need a strategy for choosing which stocks to buy.  And quite frankly, IPO stocks should rarely, if ever, fit that strategy.

What is an IPO?

IPO stands for Initial Public Offering.  In other words, a stock’s IPO is the process by which the company issues its first shares of stock to the public.

The stock in question- Snapchat- has their IPO set for Thursday, March 2.  In other words, starting on 3/2, you’ll be able to own shares of Snapchat stock.  The starting share price is expected to be $17 per share.  However, this IPO price is only good for the second the stock launches.  After that, it will trade based on the supply and demand of the stock market. And be warned- typically, prices can be very volatile immediately after an IPO.

Up until this point, Snapchat was a private company. But now, if you buy shares of Snapchat stock (the stock ticker symbol is “SNAP”), you’ll be able to participate in their future growth.

If the value of the company continues to grow over time, you’ll be able to earn money based on the growth if you buy some of the stock.  On the other hand, if the company struggles, you could end up losing money.

Investing in IPOs Has a Mixed Track Record- At Best

So, why shouldn’t you buy SNAP shares on Thursday (March 2)? I’m not a big believer in speculating what’s going to happen in the stock market.  There’s certainly a decent chance that Snapchat will grow quickly in the next few years.  But, historically speaking, IPOs tend to have a poor track record.

Take a look at the historical stock prices of a few big companies that had highly publicized IPOs in the few years following their debut: Facebook, Twitter, Visa, Alibaba, and Groupon:

Facebook

Twitter

Visa

Alibaba

Groupon

Notice a trend here?

Some of these stocks have done incredibly well over a long time period- Facebook and Visa in particular.  But on the other hand, Groupon is still struggling today- as of this writing, its current price  is 84 percent lower than the trading price immediately after it went public.

In the short term, IPOs tend to be very volatile in price.  More often than not, the market views the stock as overvalued when it is initially launched.  For this reason alone, I don’t recommend buying shares of just about anything the day it’s released.  Snapchat included.

Of course, past market performance doesn’t necessarily reflect what will happen in the future.  And even people who bought Facebook when it debuted, and held it through today, have done very well.  But frankly, this misses the broader point.  I view investing in stocks like SNAP as a gamble- it could pay off, or you might lose big.  I prefer an alternative method to gambling in the stock market…

You Need an Investing Strategy and Methodology

I don’t recommend that you invest in companies by chasing the proverbial shiny object.  Instead, set some investing goals for yourself, and use a methodology to help guide your investments to meet these goals.

What are you trying to accomplish with your investments?  How much risk are you willing to take?  How long will you keep the money invested?  If your investments were to fall by 10 or 20 or 30 percent, what would you do?  These are critical questions that you need to ask yourself to guide what investing strategy you should follow.

If your goal is to build long term wealth through your investments, I’d posit that taking a bet on a company like Snapchat might not be the best idea.  Even if it does happen to double or triple in value in the next ten years, the risk associated with an IPO like this might not make it a good choice for your long-term strategy.

Instead, I like to focus on stocks that a) have good, long track records, b) pay a steady, reliable income, c) have a history of growing this income every year, and d) appear to be well positioned for the future.  Investing in companies like this, done correctly and monitoring and adjusting your portfolio as market situations change, will position you well for long term success.

And, of course, don’t forget the need to diversify.  No matter how good a particular stock looks, you should never have more than 5% of your total investments be in any particular company.

I’m going to be sharing a lot more about this sort of framework on my upcoming webinar next week.  Register today!

And in the meantime, think long and hard before investing in a new stock like Snapchat.  Don’t gamble in the stock market- develop your investing framework, and stick to it!