Strategic Tax Filing Considerations for Married Student Loan Borrowers

by Justin Rice, CFP®, CSLP®, Personal Wealth Strategies | April 2, 2024

Picture this scenario: A happily married couple strolls into your accounting office with beaming smiles and shared financial goals. As a seasoned accountant, you're accustomed to the rhythm of joint tax filings and the typical benefits that they provide. But hold on, there's a twist. This couple is contemplating the unconventional move of filing their taxes separately. Now, in your world, that might elicit a quizzical look — a furrowed brow, perhaps, as the norm is typically "married filing jointly." However, when student loans enter the scene, the traditional tax-filing status quo takes an intriguing turn. While conventional wisdom often leans towards joint filings, the student loan factor introduces a new dynamic that shouldn't be overlooked.

The Differences

For married individuals grappling with student loan debt, the decision on tax filing status — whether to choose "married filing jointly" (MFJ) or "married filing separately" (MFS)—is a pivotal one. Not only does it impact their tax liability and monthly loan payments, but it also influences eligibility for crucial tax credits and benefits.

To comprehend the nuances, let's first explore the correlation between federal student loans and the tax filing status. Borrowers on income-driven repayment (IDR) plans, such as Pay As You Earn (PAYE) and Income-Based Repayment (IBR), traditionally had the option to file taxes separately, isolating the loan payment calculation to the borrower's earnings only and excluding the spouse's income from the calculation. Not all IDR plans allowed this initially, but with the recent changes and introduction of the innovative Saving on A Valuable Education (SAVE) plan, it now extends to all plans.

You might wonder, “Sure, filing separately may shrink the monthly student loan payments by excluding spousal income, but is it merely a short-term fix?” Not quite. Enter the aforementioned innovations of the SAVE plan, revolutionizing how unpaid interest is handled. Under this plan, any unpaid interest is entirely subsidized. In simpler terms, if the calculated payment based on income falls short of covering the monthly interest, that additional interest doesn't pile up on your loan balance; it simply vanishes.

Nonprofit or Governmental Careers

Furthermore, what if the client has a career in a nonprofit organization or governmental agency? Here's where things get really interesting. By making 120 monthly payments under the Public Service Loan Forgiveness (PSLF) program, the client can qualify for complete tax-free forgiveness. Yes, you read that right — after a decade of dedicated service, the entirety of their outstanding balance evaporates. I've personally advised on this type of forgiveness and have helped 16 clients qualify for a combined $2.6 million of forgiveness. So, it's very real!

Now what if the career path doesn't qualify for PSLF like for-profit ventures or entrepreneurship? Fear not, there's still a path to forgiveness, it will just take a little longer. Depending on the chosen IDR plan and the loan type (undergraduate versus graduate), the loans would become eligible for forgiveness after 20 or 25 years. So, by minimizing payments through strategic tax filings, you're not just reducing out-of-pocket costs now; it's a calculated move towards maximizing forgiveness and securing a brighter financial future.

So, it sounds great, but why would someone not want to file separately? This is where you come in. Couples filing separately often find themselves in higher tax brackets, leading to increased overall tax liabilities. Subsidized healthcare coverage, dependent childcare credits and other deductions can be compromised when couples opt for separate filings. Notably, Marketplace healthcare plans may be impacted, potentially forfeiting premium tax credits and other savings (with exceptions in cases like domestic abuse or abandonment). Couples may face additional taxes ranging from $2,000 to $3,000, coupled with limitations on IRA contributions and eligibility for Roth IRA contributions. Understanding these nuances is vital, and having a competent accountant like yourself advise on these adverse ramifications is critical.

Amending Returns

It's vital to address another significant aspect of tax filing status: the prospect of amending returns. When contemplating the possibility of amending tax returns from MFS to MFJ, it's essential to proceed with caution, especially considering the legal gray area surrounding such actions when it comes to student loan income recertification. While this pathway may hold the potential to recoup missed tax benefits, it's prudent to delay amendments until the tax return no longer influences current student loan payments.

All of these decisions should undergo thorough scrutiny on a case-by-case basis, factoring in individual circumstances and long-term financial objectives. Engaging in discussions with a qualified student loan expert can provide invaluable guidance, ensuring that any action taken adheres to legal and financial best practices.

Justin W. Rice

Justin W. Rice

Justin Rice, CFP®, CSLP®, is a financial advisor with Personal Wealth Strategies. He was the first advisor in New Jersey to obtain his Certified Student Loan Professional (CSLP®) designation in 2019 and is the president-elect of the Financial Planning Association (FPA) of New Jersey.

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