When filing separate returns, each spouse will report as income his/her wages and net earnings from self-employment, the income (interest, dividends, capital gains, rents) from separately-held assets (bank accounts, investments, rental property), and one-half of the income from jointly-held property.
There is an exception for married couples living in “community property” states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin). In such states each spouse usually must report one-half of the total “community income” (income from community property and wages for services of either spouse) unless the couple lived apart (i.e. maintained separate residences) for the entire year.
Each spouse can deduct only those expenses that he/she has actually paid, and for which he/she is legally responsible. Expenses paid from separate funds (i.e. the wife’s separate checking account) are considered to be paid by that spouse, while expenses paid from joint funds (a joint checking account) are considered to be paid equally by each spouse unless they can prove otherwise.
The wife makes a $500.00 charitable contribution from her separate checking account. She can claim the entire $500.00. The couple makes monthly contributions of $100.00 to their church from a joint checking account. Each spouse can deduct $600.00.
Medical expenses are deducted by the spouse that makes the payment, regardless of which family member incurred the medical costs. A wife can deduct medical bills for her husband that she paid from her separate checking account, even if she is not legally responsible to do so.
If real estate is owned by only one spouse (vacation property owned by the wife), only that spouse can deduct the related property taxes, and only if that spouse has actually paid the taxes. Property tax paid on jointly-owned real estate is deducted under the guidelines discussed above.
Mortgage interest is only deductible by a person who is legally liable for that mortgage. For a mortgage on jointly-held property, where both names are on the mortgage, each spouse can deduct the amount of interest that he/she has actually paid, using the guidelines discussed above. In the case of more than one jointly-held property (personal residence and vacation property) each spouse can deduct the mortgage interest on one home, unless both spouses agree (in writing) that one spouse will deduct the interest on both properties.
In the case of claiming dependents, the only guidance I have been able to find on allocating exemptions between the spouses is in Internal Revenue Service Publication 555 – Community Property. Here is the example provided in Pub 555:
“Ron and Diane White have three dependent children and live in Nevada [a community property state - rdf]. If Ron and Diane file separately, only Ron can claim his own exemption, and only Diane can claim her own exemption. Ron and Diane can agree that one of them will claim the exemption for one, two, or all of their children and the other will claim any remaining exemptions. They cannot each claim half of the total exemption amount for their three children.”
There seems to be no set rule for determining which spouse can claim which dependent on separate returns. In the above example, Ron could claim 1, 2, 3, or none of the children, with Diane allowed any of the children not claimed by Ron. This example is not new, and has appeared in Pub 555 for many years. While it is written specifically for a community property state, the same rule should apply in other states. If a tax professional reading this can offer any other guidance on how to allocate dependents on separate returns please send me an email, or provide a “comment” to this posting.
If the spouse with the lower Adjusted Gross Income claims the dependent children there may be additional tax savings due to an increased Child Tax Credit. You should do multiple calculations and allocate any dependents in a manner that will provide the greatest overall tax savings.
Of course in the case of spouses who live apart during at least the entire last six months of the year, the “custodial” parent will get the dependency exemption. In some cases the custodial parent may also be able to file as Head of Household.
Any questions?
TTFN
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