THE TAX LAW relieves most Social Security recipients of income taxes on their monthly checks. But it requires middle- and upper-income households to count up to 85% of their benefits as reportable income. Sound punishing? It can be especially punishing for couples who are cutting the knot—but they may live happily ever after.
Taxes on Social Security benefits are triggered when recipients’ MAGI exceeds specified amounts. MAGI is an acronym for modified adjusted gross income (and not the term for the three wise men who bore gifts to the infant Jesus). It’s essentially the same as adjusted gross income—but with two potential add-ons: Taxpayers may have to include part of their Social Security benefits and any tax-exempt bond interest.
Social Security recipients don’t have to count any of their benefits when MAGI is below $25,000 for single taxpayers and $32,000 for married couples filing jointly. But when MAGI is between $25,000 and $34,000 for single persons and between $32,000 and $44,000 for joint filers, they must count as much as 50%. The count can get as high as 85% when MAGI surpasses $34,000 for singles and $44,000 for joint filers.
That brings us to those who are divorcing. There’s a much-misunderstood restriction for couples who opt to file separate returns because, say, they’re getting divorced. Generally, if a couple files separately, their exemption drops from $32,000 to zero, with a precisely worded exception for spouses who don’t reside together at any time during the taxable year. Stated another way, a couple who live together, even for just a day, and file separately aren’t allowed any exemption and must count 100% of their Social Security benefits as reportable income.
This trap snared Thomas W. McAdams, a retired Army colonel. Tom and his wife Norma stayed married but lived apart, she in the home they owned in Boise, Idaho, while for many years he lived most of the time in Ninilchik, Alaska, and other locales far from Boise. The estranged spouses listed themselves on their 1040s as “married filing separately.”
During an audit of Tom’s return, the career officer forgot that loose lips sink ships. Tom inadvertently divulged that he stayed in Norma’s dwelling for more than 30 days during the year in issue, though he always slept in a separate bedroom.
That admission convinced the Tax Court to agree with the IRS that Tom didn’t, as the law specifies, “live apart” from his wife “at all times during the taxable year.” The 2002 decision deconstructed living apart to mean only living in separate residences, not separate areas of the same residence. It held that his visits disqualified him from any exemption. Result: His benefits didn’t sidestep taxes.
But once divorced, couples may find their lives are less taxing. Whether by design or inadvertence, Congress crafted rules that require a person to pay more taxes on benefits solely because he or she is married. How so? Two single persons who share quarters without benefit of clergy can each have an exemption of as much as $25,000 before any of their benefits are taxable. With a combined base amount of $50,000, they gain an advantage of $18,000 over the $32,000 threshold for a married couple—an aspect of the law that’s a “marriage penalty” or “sin subsidy,” depending on one’s point of view.
To be sure, most couples wouldn’t divorce just to trim the taxes on their Social Security benefits. But for a tax-conscious couple contemplating an unhitching, the prospect of sizable savings at filing time could well be the clincher—even if they remain committed to one another.
Indeed, to put more of their benefits beyond the IRS’s reach, all they need do is divorce and then live together out of wedlock. A beleaguered IRS readily concedes that as long as their “un-altared” arrangement remains unaltered, each would become entitled to use the base amount of $25,000 for a single person. Their unhitching (or forgoing that walk down the aisle to begin with) would enable them thereafter to live a more prosperous life in unwedded bliss.
Julian Block writes and practices law in Larchmont, New York, and was formerly with the IRS as a special agent (criminal investigator). His previous articles include Execution Matters, Taking Shelter and For the Record. This article is excerpted from Julian Block’s Tax Tips for Marriage and Divorce, available at JulianBlockTaxExpert.com. Follow Julian on Twitter @BlockJulian.