Married Filing Separate May Be in Play
In the 35 years plus of being a CPA I have filed a married filing separate return on an elective basis likely less than 20 times (some couples prefer to file separately). With the new Section 199A 20% of business income deduction being limited to various phase-outs, 2018 may be a tax year where I file several extra separate tax returns. Here are some of the times where it may make sense to file separately:
- One spouse has a high source of income and the other spouse has specified service business (SSB) income. Once a married couple goes over $415,000 of taxable income, none of the SSB income will qualify for the 20% deduction. However, if the spouse with the SSB income is under $157,500 of taxable income (before the 199A deduction), they may qualify for a full 199A deduction on that income.
- Each spouse has qualifying income, however, due to being over the threshold levels, the phase-out based on wages or qualifying property may lead to a substantially reduced Section 199A deduction for one or both spouses.
Here are examples for both situations:
John is an employee of ABC Farm Goods Inc. and earns a wage of $300,000. Mary, his spouse has a Schedule C SSB business that earns $180,000. They utilize the standard deduction. If they file joint, they owe about $107,280 of federal income tax. If, instead, they elect to each file separate income tax returns, John will owe about $76,490 of tax and Mary will now have a Section 199A deduction of $31,486 (limited to 20% of taxable income). This results in tax of $24,516 which when added together equals $101,006 saving $6,273.
Bert and Ann are farmers. Bert has a S corporation that pays him $100,000 of wages and nets $200,000, thus qualifying for a $40,000 Section 199A deduction. Ann has a Schedule F that generates $180,000 of income, however, she pays no wages and has no qualifying property. The tax owed by a joint filing is $93,279 ($40,000 Section 199A deduction allowed for Bert, nothing for Ann). By filing separate, their total tax is reduced to $87,006 saving the same $6,273 as John and Mary since Ann is allowed the same extra $31,486 deduction.
Although there is not a huge savings from filing separately, the cost of preparing separate tax returns is not a major item. Most of our software prepares these returns with minimal effort. However, if you are farmer in a community property state, this likely will not help you. Community property taxpayers are required to report each other’s income 50/50.
Paul Neiffer is a certified public accountant and business advisor specializing in income taxation, accounting services, and succession planning for farmers and agribusiness processors. Paul is a principal with CliftonLarsonAllen in Walla Walla, Washington, as well as a regular speaker at national conferences and contributor at agweb.com. Raised on a farm in central Washington, he has been immersed in the ag industry his entire life, including the last 30 years professionally. Paul and his wife purchase an 180 acre ranch in 2016 and enjoy keeping it full of animals.
Paul,
If a farmer trades with a co-op, and that farmer has wages, the farmer will likely have a reduced 199A deduction compared to trading with a private elevator. However, if that farmer pays his workers in commodities, he will avoid the wage limitation and will be able to obtain the same deduction as if he traded with a private elevator. Section 3121 (a)(8) excludes payment in commodities from the definition of wages for this purpose. Do you agree?
Thanks for any input!