MFJ vs MFS with one working spouse and large LTCG

[dolphine1234]

(I have learnt great deal from this community. Thanks ahead for responses)

We have been filing MFJ with 2 dependents for all past years in CA, this year we are thinking if MFS will be beneficial because one spouse is not working.

Spouse 1: W2 income: 500k

Spouse 2: W2 income: 0

LTCG (joint accounts) : 80k

Dividend + interest: (joint accounts): 40k

If MFS, Spouse 2 will get a lower LTCG rate and no NIIT, given this situation, is it better to MFS since we were not eligible for all the credits allowed for MFJ due to high income?

[tagteam]

I will page @Mike9241. Please check later.

[Mike9241]

can't answer for sure. you really need to do 2 MFS returns and a joint return. you pssibly can do this udsing online and viewing summary results. desktop would allow you to review all 3 returns in their entirety

i did some guesswork and did two separate returns and a joint with a lot of guesses.

what i came up with is only Federal results

as MFS both of you would have a combined tax liability of $160K

but filing a joint return only about $133K

reason is simple the MFS rates are much higher on your share of taxable income vs the rates for joint.

for joint it's like each of you earned 1/2 the income so you pay 2 times the tax on 1/2 the combined taxable income 

put another way $310K of split income using joint rates has a marginal tax bracket of 24%

$560K of MFS income hits the 35% bracket

but like I said my numbers are pure guesstimates but the results conform to what's expected when 1 spouse has a lot of income and the other virtually nil and they file MFS 

[rjs]

@Mike9241 

In your guesswork MFS returns, did you take into consideration that they are in a community property state?

It's not clear whether the OP treated community income correctly in his/her MFS analysis. The OP said that Spouse 2 would have a lower tax rate on long-term capital gain. I don't understand why that would be, since all the income mentioned in the question would have to be split 50/50. But I have not done trial returns.

Based on my limited knowledge of community property, it seems to me that the two MFS returns would be identical, since all of the income has to be split equally between the two.

[dolphine1234]

OP here. I didn't know all income need to be divided equally. I thought W2 income just stays with whoever is earning it.

[Mike9241 · Accepted solution]

nope. as I pointed out to them they need to do the 3 returns.  it would seem based on the data provided all income would be community property thus each would report $310K of income on their MFS returns which in theory would be the same in combined taxes as a joint return.  

[TomD8]

This TurboTax help article might be useful:

https://turbotax.intuit.com/tax-tips/marriage/five-tax-tips-for-community-property-states/L4jG7cq7Z