Filing married but separate to lower student loan payment

[ljb322]

My daughter has a significant amount of student loan debt (approx. $100k) She and her husband have been filing jointly on their taxes but recently were told that if they file married but separate, it could reduce her student loan payment. She also qualifies for the PSLF program and has submitted the appropriate paperwork for that. Is it wise to file separately in this situation? 

[KusyJ]

Married Filing Separately (MFS) removes eligibility for a number of credits, deductions and benefits provided by Married Filing Joint (MFJ) filing status. 

MFS filing status potentially results in the following situations:

1. Higher tax liability because of a lower standard deduction for that status. Each spouse’s income will be taxed at the Single rate.
2. Itemizing deductions can be potential problems. If one spouse itemizes deductions, the other spouse is required to itemize deductions even if that spouse has no deductions. This situation erases any standard deduction potentially increasing tax liability.
3. MFS filing status cannot deduct student loan interest and education deductions.
4. The Child and Dependent Care deduction may be eliminated.
5. Typically, you will lose eligibility for the Earned Income Credit.
6. The Retirement Savings Contributions Credit will be reduced to have the benefit of filing MFJ.
7. MFS filing status can potentially reduce or eliminate eligibility for the Child Tax Credit.
8. Retirement Contributions may be limited under the MFS filing status. 

The MFS filing status affects other credits and deductions as well.

The taxpayers will have to complete their own cost benefit analysis to determine which option offers the most beneficial financial outcome. You will have to estimate your tax liability and compare that to the benefits offered by the Income-Driven Repayment (IDR) program for lower the student loan payment. In other words, which option provides the greater benefit at the end of the year.

[SwapnaM]

Pros of Filing Separately:

1. Lower Student Loan Payments: If your daughter's income is lower than her husband's (or if she has substantial loans compared to her income), excluding his income from the IDR(income driven repayment) calculation can lead to substantial monthly savings on her student loan payments.
2. PSLF Program: By paying less each month, a larger portion of the $100,000 debt will remain at the end of the 10-year PSLF period, which will then be forgiven tax-free.

Cons of Filing Separately:

1. Loss of Tax Benefits: Filing separately can result in the loss of certain tax benefits, such as the Earned Income Tax Credit, Child and Dependent Care Credit, Education credits and the ability to deduct student loan interest.
2. Higher Overall Taxes: The combined tax liability for the couple might be higher when filing separately compared to filing jointly

They may have to run the numbers using both filing status & compare the numbers.

@ljb322 Thanks for the question!!

[DRich5]

@ljb322  - Great question.  In some cases, married couples can result in lower student loan payments if the student loans are repaid under the "income-driven repayment (IDR) plans.  By filing separately, a borrower's monthly payment under an IDR plan is based on their own discretionary income.  When filing jointly, payments are based on both spouse's income.  

However, filing separately as a couple could cause the loss of tax benefits such as certain credits and deductions, including the student loan interest deduction, American Opportunity Tax Credit (for educational expenses), Earned Income Tax Credit, the Child Tax Credit and the Child and Dependent Care Credit.  

The Public Service Loan Forgiveness for being employed with the government or not-for-profit organization will not be impacted by the IDR payment amounts.  The program forgives the remaining balance on your direct loans after you have made 120 qualifying monthly payments (10 years) while working full-time for an eligible employer.  

The suggestion is to determine the household situation, income, how many children/dependents, additional educational costs, tax liability using married filing joint v married filing single and weighing it against the fluctuation of the student loan payment. 

You can use the Federal Student Aid Loan Simulator https://studentaid.gov/loan-simulator/ or the specialized IDR calculators to determine the monthly payments under different repayment plans and tax filing statuses.