As we enter into this year’s prime tax season, many recently married couples face a new problem when filing their taxes. This is a new problem they probably did not discuss but could have a significant impact on their financial future. The advice for repaying student loans and marriage is limited. If you call the loan servicers, they cannot give advice on personal financial issues, like taxes. The goals of your CPA and tax advisor are to reduce your tax exposure but that may not be the best advice for repaying your student loans or loan forgiveness.
Once the rules of the Income Driven Repayment Methods (IDR) were established student loan repayment for married couples became more complex. The IDR methods are based on the modified adjusted gross income of a person. The decision is easy, as a single tax filer. Once you get married, you have a completely new set of options. You can file married and joint or file married and separate.
Married Filing Joint vs Married Filing Separately
The majority of married couples file their taxes married and joint since it normally is the most tax effective. There are a few exceptions and couples with student loans are one of them. If one of the spouses has federal student loans and is enrolled in an Income Driven Repayment (IDR) method then that couple will need to investigate filing their taxes as married and separate.
If the couple is using a fixed federal repayment method or has only private student loans then the tax filing concern is not an issue. They can file the most tax efficient way.
On the other hand, if one of the spouses is trying to qualify for Public Service Loan Forgiveness, that borrower will be enrolled in an Income Driven Repayment method. The reason why filing married and separate becomes an advantage is the modified adjust gross income will be lower since it is by person and not summed as a couple. This could result in a significantly lower monthly loan repayment amount.
There is one exception to the IDR methods regarding filing married and separate. If one of the spouse is using the Revised Pay as You Earn (REPAYE) this will sum the married couples income no matter which way they file to calculate their monthly payment.
Student Loan Interest Deduction Married Filing Separately
When filing your taxes married and separate, there are added tax risks and lost deductions. By filing married and separate, the couple loses the student loan interest deduction. This did not change under the new tax rules. It is a $2,500 deduction based on the modified adjusted gross income of the individual and the couple.
If both spouses have student loans and file their taxes as joint, they will be limited to the $2,500 amount. This is another loss since as single filers both could claim the $2,500 deduction if both had student loan interest. There are income limits to qualify for this deduction based on the filing method.
Another major risk by filing married and separate is the risk of Alternative Minimum Tax or AMT. This occurs mostly in higher income couples. It was maintained in the new tax code.
Importance of Keeping Your Federal Student Loans
To qualify for IDR method the borrower needs to have federal student loans. If both spouses have federal student loans, the complication of filing their taxes is not as critical. If both spouse have federal loans the benefits of filing married and separate is not as beneficial.
In the case when both husband and wife have federal student loans, the modified adjust gross income is different. Their joint income is prorated based on each of their loan balances and not their individual income. There is a risk here if one borrower refinances their federal loans to private loans. The prorating of income is lost since only one spouse has federal loans.
Another important note regarding private student loan refinancing, once you leave the federal loan repayment process, the borrower is unable to re-enter the federal repayment method with those loans.
Student Loans and Marriage Summary
For married couples that have student loans, this is not an easy decision. It is important to get your taxes done by a tax professional both as joint and separate filers. Understand the tax differential and then compare it to your student loan repayment options is critical.
There is some good news for the recently married couple. Depending on your student re-authorization date, the loan servicer may still be using your tax return from the prior year. This will delay this pain for a year but without the proper planning, a financial surprise could occur based on the first year’s tax filing as a couple.
As the holiday season and Valentine’s Day have just concluded, many couples have been engaged. Having a discussion on money and specifically student loans may not be a bad idea.