The 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 percent of their benefits as reportable income. Sound punishing? It can be, especially for couples who divorcing. Fortunately, they may still 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 their MAGI is below $25,000 for single taxpayers and $32,000 for married couples filing jointly. But when it 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 percent. This percentage rises to 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 splitting up.
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 lives together, even for just a day, and files separately isn’t allowed any exemption and must count 100 percent 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 resided in the home they owned in Boise, Idaho, while 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. He 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. As a result, his benefits didn’t sidestep taxes.
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 the 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 pair 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 agency 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.
Best Wishes to My Readers for a Happy New Year. As someone who keeps his creditors at bay only because he has a certain talent for demystification of the Internal Revenue Code, I would be remiss in the discharge of my obligations to you were I to fail to note that “year” includes, but is not limited to all calendar, fiscal and taxable years. Consistent with the Joycean murkiness of Code Section 441, “taxable year” includes regular and short taxable years as well as taxable years having 366 days.
About Julian Block
Attorney and author Julian Block is frequently quoted in the New York Times, Wall Street Journal, and the Washington Post. He has been cited as “a leading tax professional” (New York Times), an “accomplished writer on taxes” (Wall Street Journal), and “an authority on tax planning” (Financial Planning magazine). More information about his books can be found at julianblocktaxexpert.com.