Improving Student Loan Outcomes When Filing Taxes Married Separately

Using income-driven repayment (IDR) plans toward student loan forgiveness can be a favorable way for optometrists to manage student loan debt. In this episode Evon talks about how strategically changing the way you file your taxes when married can improve the long-term math toward student loan forgiveness.

He dives into how filing taxes married filing separately can exclude your spouse's income from your student loan calculation on an IDR plan and impact the family size for the calculation - as well as the tax consequences of changing your tax filing status.  He also talks about how community property states open up even more planning opportunities for student loans when filing separately.

Lastly, he talks about important considerations to keep in mind around the tax filing deadline and your recertification date.

Have questions on anything discussed or want to have topics or questions featured on the show? Send Evon an email at podcast@optometrywealth.com.

Check out www.optometrywealth.com to get to know more about Evon, his financial planning firm Optometry Wealth Advisors, and how he helps optometrists nationwide. From there, you can schedule a short Intro call to share what's on your mind and learn how Evon helps ODs master their cash flow and debt, build their net worth, and plan purposefully around their money and their practices. 

Resources mentioned on this episode:

• Federal Student Aid - Income-Driven Repayment Plans
• Federal Student Aid IDR Plan Request Form PDF
• Optometry Money Podcast Ep. 89: 2024 Financial Updates Optometrists Need to Know
• The Optometry Money Podcast Ep 74: Student Loan Planning for Optometrists in 2023 and Beyond!

The Optometry Money Podcast is dedicated to helping optometrists make better decisions around their money, careers, and practices. The show is hosted by Evon Mendrin, CFP®, CSLP®, owner of Optometry Wealth Advisors, a financial planning firm just for optometrists nationwide.

Transcript

Evon: 0:04

Hey, everybody. Welcome back to The Optometry Money Podcast, where we're helping OD's all over the country make better and better decisions around their money, their careers, and their practices. I am your host, Evon Mendrin, Certified Financial Planner(TM) practitioner,, and owner of Optometry Wealth Advisors, an independent financial planning firm just for optometrists nationwide. And thank you. Thank you. Thank you so much for listening today. And it is officially tax season, which has gotta be high pretty high up there in the list of most joyous seasons of all, of course oozing with sarcasm there. we are now getting into the thick of it. And, uh, perhaps you are thinking about gathering all the documents you need to get your personal tax return filed for 2023's tax year. or if you own a practice and you're taxed as a partnership or an S-corporation. you and probably your tax professional are hard at work, getting what's needed for those specific tax filings. And in light of the tax filing season, I wanted to talk about an important intersection between how you file your taxes and student loan planning. So why is tax filing status important for student loans? Well, this is especially important. If you are using income-driven repayment plans towards some sort of forgiveness, whether it's taxable forgiveness in 20 to 25 years. Or whether it's PSLF And especially if you're married. And the reason is because if you think about these IDR income-driven repayment plans, these IDR plants calculate your student loan payments based on your income and family size. The lower your income, and the the higher your family size. the lower your payments and the lower your payments means the lower, the total cost of the debt over time up until the year forgiveness. And so tax filing status determines whether or not, if you're married your spouse's income is included in your payment calculation. Whether you file taxes, married, jointly or whether you filed taxes, married, filing separately. And how you file taxes also changes how payments are divided up between the two of you if you both have federal student loans. If you are filing taxes jointly, y ou're essentially calculating a household payment for the two of you if you're both on income-driven repayment plans. And then that household payment is divvied up proportionally between the two of you, depending on who has, what percentage of household federal debt. So if you have 60% of the households, federal debt and your spouse has a 40%, then 60% of that household, payment's going to go to your debt 40% to your spouse's debt. So it weighs more heavily on who has the larger amount of federal debt. If we file taxes separately it changes that. It basically has you calculate your separate payment which goes to your separate loans. And in a lot of situations, filing taxes separately can make sense for student loan payments. Now. It's important to say how you file your taxes certainly has an impact on the tax bill. making the decision to do file your taxes, married, filing separately when you're married. definitely impacts your taxes. And if you talk to almost any tax professional, Enrolled Agent or CPA, they're usually going to tell you that filing taxes separately, rarely if ever makes sense. And that tends to be the case. It's usually going to increase your tax bill in some way uh, due to several things. number one, it's going to impact the effective tax rate that you pay. Because when you file taxes separately for each spouse, the tax brackets are essentially cut in half. They shrink. And if one spouse has a much higher amount of income than the other. Or if one spouse is the only working spouse and you have a lot more income getting shoved into much smaller tax brackets, so it can have a negative impact on the effective tax rate. Of course, that changes if you are in a community property state, which we'll we'll talk about later on. Uh, but that's, that's a consideration there. It also impacts certain credits or deductions, for example, the child and dependent care credit, which is a 20 to 35% credit that you can get for certain dependent care costs like daycare. If you and your spouse are both working. And if you file taxes separately, you cannot claim that credit. You're an ineligible to get that. If you or your spouse have dependent care flexible spending accounts, dependent care FSA. Um, your contributions each are limited to 50% of the family total. So$2,500 each. So if only one of you has a dependent care FSA and you've been putting the full family maximum into that single FSA, your max is now cut in half. it's, it's not as bad as both of you have access to that, but if only one of you does, it can limit your deduction there and the amount that you can put in. The adoption credit is eliminated. IRA contributions are impacted. So if you've been putting dollars into a Roth IRA directly, because your income is low enough as a household to, by filing taxes separately, it's going to lower the income threshold to contribute directly to Roth IRA so low, down to$10,000, that it's essentially going to force you to do what we call backdoor Roth IRA contributions. Which, which continues to confuse optometrists everywhere. what's commonly called the backdoor method of getting dollars into the Roth IRA. Is really taking two entirely unrelated transactions and putting them together, which is a number one a non-deductible contribution to a Traditional IRA. And then number two, separately, a conversion from, or transfer from, a Traditional IRA over to a Roth IRA. And in that case, you got to watch out for any pre-tax IRA dollars you have an, any other IRA, like a simple IRA even, or a SEP IRA or a Traditional IRA. because those dollars can cause tax issues here. But it's going to force you, if you file taxes married separately to now have to do backdoor Roth IRA contributions. it also impacts the child tax credit. Which is available for children that you claim as a dependent on your tax return that are 16 years old or younger. And only one parent can claim each child and then take the credit. But it also lowers the income limit, which is the modified, adjusted gross income limit from$400,000 as joint filers to$200,000 per spouse. So again, if one spouse has a much higher income than the other, you can potentially run into issues there where you're phasing out of the child tax credit. if your income was low enough where you can get the student loan interest deduction, you lose the ability to take that. capital losses. If you sold a bunch of stuff at a loss throughout the year. in a taxable brokerage account, for example, and you had losses left over at the end of the year as a joint filer, you can take up to$3,000 of those losses and offset all of your other income. If you file taxes separately, that's split in half between the two of you. If you file separately, you're not eligible to get a premium tax credit for health insurance that you buy on the exchange. Which is important if you're cold starting and you find that your income is going to drop low enough to where that's an important consideration having to find healthcare, and you would be low enough relative to the poverty line amount that you're eligible for those premium tax credits. That's a consideration as well. So there's all of these different tax issues, whether it's the tax rates themselves or certain credits or deductions that you can get. that you do need to keep in mind and can often lead to a higher tax when filing separately as a household versus filing joint. That being said. It is often the case that in spite of that, filing separately has such an impact on your student loans, that it's still makes sense to file separately. Just because of the benefit of student loans. So let's talk about what student loan planning opportunities exist. When you're filing taxes married filing separately. And as we talked about earlier, the big benefit of filing taxes separately, when it makes sense, is that it allows you to exclude your spouse's income from the student loan calculation. whereas when you're filing taxes jointly, you have to include both spouses. So, if both of you are working, this can be a pretty big impacts on the student loan calculation for, for you, if you are the spouse with the student loans or for both of you, if you both have federal loans and you're both on income-driven repayment plans. And it's going to make sense where the student loan savings is higher than the extra taxes that might come and the filing costs for filing separate. And. The opportunity's really common two sort of forms. Number one, if you are in a community property state, or number two, if you're not. And, i n a non-community property or in a, a common law state. this can make sense most often when spouses have similar incomes where the extra tax is not going to be substantial. Or when you have federal loans and you're the lower earner, that means you can exclude your higher earning spouse's income and you can benefit from having the lower, the lower income And a lower IDR plan payment. Uh, it can get a bit more complicated when both spouses have high amounts of federal loans. You really need to look at the math for your particular situation. But, but it still can benefit you in that situation as well. Where both spouses have high income and high federal debt. How you file your taxes can impact your family size for income driven payment calculations, which is important because again, the larger, the family size, the more of your income that shielded from the calculation, which means that you have lower payments. And if you look at the way that family size is defined. as long as you're not providing the IRS consent to automatically pulling your income information, or if you're choosing to provide alternative documentation of your income, like using pay stubs, for example, instead of your tax return, if you're hopping on the Pay As You Earn plan or the IBR plan income-based repayment, your family size will always include your spouse. Even if you're filing separately. However, for the SAVE plan, if you're hopping on the most recent SAVE plan, even though you can now exclude your spouse's income on the SAVE plan if you file separately. If you do that, you can no longer include your spouse in your family size for that calculation. So it's going to impact your family size as well for the way that your payments are calculated. it can also impact the way that your children show up in your family size. So it, so it impacts that part of the calculation as well. There are even more planning opportunities when filing taxes separately, when you live in a community property state, and this is really where this is really where the rubber meets the road. In all cases, you have to look at the math at what the student loan impact is going to be as well as what the tax impact is going to be when you're making a decision on how to file your taxes. In all cases. But it's in a community property state where you really start to see even more planning opportunities open up. So what are community property states? Well, there's nine of them. that's California, Texas, Louisiana, Wisconsin, Washington, Idaho, Nevada, Arizona, and New Mexico. So it's essentially the Southwestern corner or as side edge of the United States. which are, if I know my history correctly, it's based on old Spanish law. Or randomly Louisiana and then way up north Wisconsin, which are based, I believe on French law. And, the way that community property states work in terms of federal taxes, is that income earned while you're married is considered community property income. And for federal tax purposes, your adjusted gross income, your income on your tax return is split evenly between the two of you, regardless of who has higher or lower income. On your federal tax return, when you file taxes separately, it's going to be split up evenly between the two of you. And you should, as you're looking at a separate tax return for each of you, you should see Form 8958. Which. Essentially adds up and splits apart the different sources of income that you have between the two of you. So essentially what happens is that for tax purposes, for federal tax purposes, There isn't this massive increase in taxes due to tax rates because it divides up your income evenly between the two of you. And there's still the impact on credits and deductions. That's still going to happen. So you still might see a small increase in taxes. But it's not going to be a substantial impact between the two of you, especially if one spouse earns a much higher income than the other. And what happens for student loan planning purpose is that if the higher earner is on an income-driven repayment plan. They're able to essentially lower their income for student loan purposes because they can now show their tax return, their separate tax return. Which has added up the household income and then cut it in half. So you're able to show and use your tax return when recertifying your income and use a lower income for student loan purposes. So imagine a spouse, for example, that has a much higher income than the other. So for federal student loan purposes, your income has been cut down because it's added up all of your income and cut it in half. Or imagine if only one spouse is working and that spouse is on an income-driven plan, you essentially now are able to cut your income in half when you live in a community property state and file taxes separately for student loan purposes. I mean, that's, that can be a substantial change in the math when deciding which route to take your student loans. And for the lower earning spouse, if you also have federal loans and you're also on a, an income-driven repayment plan, you can still use your, you can still use alternative documentation to show your lower income as the lower earning spouse, which is most commonly your pay stubs. Or if you don't work, then you can self-certify that you're not working. So by filing taxes, separate in a community property state, you're creating separate definitions of income for each spouse, when you're going to either apply for an income-driven repayment plan. Or to recertify your income each and every year. And then you can also sort of strategically use. employee benefits and pre-tax deductions, for example. deductions like pretax 401k contributions or healthcare FSA, flexible spending account contributions. You can stack these pre-tax benefits first. On the lower earning spouse, because that spouse can then use a more favorable pay stub. But it still benefits the higher earning spouse, because, because those deductions are still going to get split evenly between the two of you on your tax return. And then you can show a more favorable income by using your tax return. So. So the opportunity is really opened up in these community property states without the massive tax hit that might come. By shoving higher income into smaller tax brackets. And I've seen a lot of situations where higher earning higher earning optometrists or practice owners. Make the assumption that they're going to be earning too much to even benefit from loan forgiveness, using income-driven repayment plans. That as the practice is successful, there's no way that they're going to be able to, to benefit from, for forgiveness because their income is going to be too high. They're going to end up either paying down their loans anyways, or the TA or the cost is just going to be too high. And what I really want to get across is that that's actually not always the case. There are plenty of scenarios where either husband and wife who are both high earners or both own a practice together and both have high amounts of federal loans can absolutely still benefit from loan forgiveness, especially if they're able to heavily focus on those pretax retirement accounts. But especially if you're in a community property state, and one spouse is the higher earner or practice owner, and you're able to change the way that you file taxes and it can dramatically change the math long-term of what is the best route to take mathematically with student loans. So please don't make any quick assumptions. You want to look at the math in each scenario. And try to make an educated decision on which long-term route is the best to take regarding your student loans and. And you may still decide, Hey, ignore the math. I just want to pay'em down and get rid of it and get him out of my life. And that's perfectly fine. But at least you've taken a look at the math and you've taken a look at the different outcomes and the opportunity costs and made an educated decision. So sort of in conclusion there filing taxes definitely has an impact on student loan outcomes. you can file jointly and include your household income. As well as, include both of your federal student loan balances and how those payments are divvied up between the two of you. Or you can file taxes separately and exclude your spouse's income from your student loan calculation. And compare that to the tax consequences of filing taxes separately, and that can be made on a year by year basis. And this is really an area where you want to make sure, make sure your student loan planning and just financial planning in general is really aligned with your tax planning. you really want to make sure you're working with a professional, a financial advisor that is familiar with student loan planning. as well as a tax professional, that's willing to look at this and, and see both sides of the equation. for me, it's calculating the student loan side. It's calculating the differences between. Joint filing and separate filing from a tax projection standpoint. And then working closely together with the tax professional. But, it takes that open communication really to make this work as best as it can. So let's talk about important considerations with the timing of filing taxes and how it impacts student loans. Firstly, one thing to think about is that if your loan certification date is coming up sometime between. February and October. Or like February and September. Like if, if between now and September, the dates coming up where you need to reshow your income for student loan purposes and recalculate the next 12 months payments you might want to consider looking at whether it makes sense to file an extension of your tax filing. So when you're filing an extension, You're able to extend the filing of your personal tax return. To October 15th, essentially, you're able to extend it six months. And of course, it's important to say this doesn't extend the time that you have to pay the tax that's due. It only extends the timing of filing your tax return. So if you're going to expect to owe dollars at tax time, you're still going to have to pay those taxes by the April deadline. But you have an extra six months to actually file your tax return. And the reason that's important is because when you go to recertify your income, You have to use by default your most recent filed tax return. So, for example, we're here in 2024, which means we're talking about filing 2023 tax return. If you extend the filing of your tax return until October. And you have to recertify your income in July. Then when you recertify, you can still use 2022's tax return for the next 12 months of payments. Which if it's a much lower income or, you know, for example, if you were recently graduated or if you are, if you were early in practice ownership, maybe you recently cold-started or whatever it may be, you may have had a more favorable tax year. Which means you can sort of extend that into another year of more favorable. Student loan payments. Or maybe we're getting married and you're planning on filing taxes jointly you can potentially reuse that single tax return. So there's different ways you can look at that in terms of the timing of filing your tax return and the. the timing of recertifying your income. But you want to make sure. That you don't file your next tax return until you've successfully recertified your income. But something to consider there in terms of the timing of filing your next tax return. Another thing that matters about the timing is whether you're going to file taxes separately or jointly. And this is something you really want to look at and decide far before the April tax filing deadline. And the reason that is because if you file taxes, jointly, married, jointly. And the deadline passes. You cannot amend your tax return back to a married filing single tax return. Once you file jointly and that tax deadline passes, you're stuck with that joint tax return, which means that your student loan payments are stuck based on a joint tax return. So, if you were intending to benefit from filing separately, you have to wait until the next tax year. The, the only caveat to that is that if you are not yet past the deadline. So if you're in March and the deadlines in April, And you've already filed a married filing joint tax return. You can file what's called a superseding tax return. So talk to your tax professional about, you know, potentially filing a superseding tax return. which is basically saying, Hey, IRS, I already submitted a return, but there's a correction I need to make. And I'd like to change that return. Right? I want you to ignore that last one and only look at this one. And you can now as of 2022 file this, this superseding return electronically and there's an electronic check box to indicate that. So that's the one caveat. If we haven't gone past the deadline, that's something to consider. If you file taxes separately, however, and the deadline has passed. You can amend a separate tax return back to married, filing jointly. in fact, there's a three year window to do that. And why does that make sense? Well, if you filed the return separately for student loan purposes, And it did have a really high tax consequence then you're comfortable with, or that makes sense, mathematically. Then you can talk to your tax professional about, after the next return has been filed, potentially amending those past tax returns back to joint. You know, every few years maybe do it in bunches. And recoup some of those extra taxes that you paid. And you have a three-year window from your filing date to, uh, to amend it. So there's a limited timeframe here, but something to consider. And again, it's important to have filed your next tax return already before deciding to amend your previous one. The reason is because your student loan payments are going to be based on the most recently filed tax returns. So you want to make sure that you are, you're not putting those payments in jeopardy by filing your tax return and then immediately amended get back. Once you filed the next return the prior year's return is not going to be used for student loan purposes. So something to keep in mind there, but this is not something illegal it's well, within your rights to amend a joint tax return back to separate but something to talk with your tax professional about. And in all of these different things, right. Talk with your financial advisor. Talk with your tax professional. And make decisions that look at not just one or the other thing in a silo, but look at everything together. And that's the case with all of your financial planning. You want to be making financial decisions in light of all the different places that it can impact from student loans to cashflow, to taxes and everything. And it takes her a really deep. deep service from your professionals and a deep base of knowledge and open communications for, from your professionals to make it all work. So some things to keep in mind there, right? How you file your taxes definitely can impact both your student loan outcomes, as well as the taxes that you pay. And, tax deadlines matter and that, you know, you might want to consider filing an extension if it benefits you to reuse the last tax return you filed. And the deadline matters based on how you want to file your taxes and whether you can undo that or not. Hopefully this was helpful. As I'm probably getting across student loan planning gets a lot more complicated when you're going towards forgiveness a as your family size changes as you get married, as both are working, as both have high amounts of student loans. Things definitely get more complicated, but of course, with that, the opportunities opened up as well. So if you have any questions, of course, reach out to me at podcast@optometrywealth.Com. you can check out any resources or links I mentioned here in this episode at the show notes, which you can find at the Education Hub on my website, www.OptometryWealth.Com. And you can also check out all the other episodes and resources and articles I've written. And while you're there, feel free to schedule a no commitment introductory call. We can talk about what's on your mind financially, and we can share how we help optometrists all over the country navigate this really fun student loan and tax planning stuff. And so much more. So with that really appreciate your time. We will catch you on the next episode, in the meantime, take care.