Married Filing Separately with Student Loans

Young Couple Getting answers to their student loan repayment and tax filing questions

More married and engaged couples are facing a growing problem, student loan repayment.  The National Loan Forbearance has been a help since monthly payments have been suspended. As we enter the tax return season, these borrowers need to address their 2020 taxes now to avoid a major increase in their loan repayment.  When federal loan repayment restarts in October, many Income-Driven Repayment (IDR) amounts will be recalculated and will be using your 2020 tax return.  This year’s tax submission and planning are critical.

Money issues are the second most common reason for divorce.  What most married couples do not realize is they could have over 126 loan repayment combinations to sort through.  As an example, a married couple could see hundreds of dollars a month in payment differences based on their tax filing status and student loan debt structure decisions.

Yes, I did say 126 different combinations!

Reason for Confusion

As more borrowers select the different Income-Driven Repayment (IDR) options, more complexity gets added into the repayment process.  Getting the right advice is difficult because the loan servicers can not discuss taxes and most tax professionals do not understand Income-Driven Repayment (IDR) and Loan Forgiveness.

Student loan IDR methods do not follow traditional loan repayment methods.  IDR methods use Adjusted Gross Income as the major factor in calculating a borrower’s or couple’s monthly payment.  Married couples need to analyze the married filing separately and married filing joint tax decisions more carefully.

To properly analyze their options, the couple must review how their taxes are filed and their student debt is structured.  In the analysis, the borrower should include a projection of future income increases and future employment decisions as this may enhance future payments and allow forgiveness options.

These simple adjustments could net significant dollars.  The newly found money could go to additional retirement savings, a home purchase, starting a family, or providing additional payments toward student loans.

Student Loan Advice is Fragmented

The big reason for the confusion is the advice on loan repayment is very fragmented.  The three most common sources of advice for the borrower are the federal loan servicers, a tax advisor, and a refinancing company.  The objective of each advice provider is different.  As a result, their advice is not transparent to each other and their recommendations rarely cross over.

The loan servicers are trying to keep the borrower current and normally recommend the lowest payment.  Their shortcoming is they cannot provide any personal financial advice, especially when it comes to filing your taxes as a couple.  The married filing separate or joint could be discussed but they can only discuss each borrower individually.  The actual loan repayment calculation is different based on the tax filing submission.

The next source is the tax advisor.  Their primary goal is to lower your taxes.  In most cases, married filing separate vs. married filing joint will result in a higher tax bill.  This is the reason the tax professional will normally recommend filing jointly.  They do not see the impact on each spouse’s loan repayment options and how a simple change could deliver thousands of dollars of savings that would then be slightly offset by the tax increase.

The last source is the private lenders or refinancing companies.  Their primary goal is to lend money and have you as the borrower eventually becoming a customer.  In many cases, this option could be a good decision, but you need to understand the options and consequences.  Once a borrower decides to refinance with a private lender, they can no longer use the federal loan repayment options.  It will also limit the couple’s tax filing options due to how the federal repayment calculations work for married couples.

Until now, this consolidated view was difficult to calculate.  The PayForED student loan repayment solution now organizes the information and options in one view. Here is a quick view of one of the fields found within the Student Loan Repayer:

Tax Filing Student Loan Repayment Analysis Chart

Importance of Loan Type

As stated earlier, a couple’s debt structure will impact how their federal loan repayment numbers will be calculated.  If both have federal student loans the calculation for a couple, filing married separately is different than if they file married jointly.

If a couple files married and separate, then the federal IDR loan repayment calculation will be based on each person’s income matched to their own federal debt.  If the couple files married and joint with both having federal loans, then the monthly payment under the IDR methods will be based on the percent of borrower federal debt to the joint income.

This complexity results in many couples getting confused and not receiving the proper advice.  A couple having the proper debt structure decisions can work to their advantage. One spouse could select the IDR method and the other could select one of the fixed repayment options.  At the same time, filing their taxes married and joint to lower their tax bill could deliver the best of both worlds.

If one spouse has already refinanced their loans or does not have student loans, then the tax filing options will be limited since no federal loans can be considered.  As stated before, once a person refinances their federal loan to private loans, they cannot return to the federal loan repayment programs with those private loans.

Another factor to consider is the requirement for additional education.  Keeping your federal loans may be a better choice since it offers deferment while in school and could be consolidated in the future.

Life Changes Impact Loan Repayment Options

When is the best time to do this analysis?

We recommend that a student loan repayment analysis should be done any time there is a major life event.  Future financial outcomes depend on getting the proper advice and analysis for each change.

For married couples, who have filed their taxes together at least once, an initial review should be considered to confirm you are doing the right thing.  Other common events would be if one spouse has just completed a degree and will begin repayment shortly.  Other items would be changes in career, employer, or the birth of a child.

For engaged or recently married couples, this analysis should happen before you filed your taxes for the first time.  By pre-planning, you can avoid the stress and surprise of a significant increase in your IDR repayment.

Under the IDR methods, you must recertify your loans each year.  The recertification will use the most recent tax filing on record.

Married Filing Separately Penalty

In most cases, the couple who submits their taxes as married filing separate will pay higher taxes.  There are a few reasons for this outcome.  If you file your taxes separately, you lose the student loan interest deduction and the income tax rate table is higher.

The problem is the tax advisor never sees the potential upside on your loan repayment options by filing your taxes separately.  This is especially important for those couples where one or both qualify for Public Student Loan Forgiveness (PSLF).  It is our theory, that due to this lack of knowledge and transparency, many people leave the PSLF program because of inadequate advice.  This will become more obvious with the case student and chart below.

Couple’s Loan Repayment Case Study

Here is an example of how much a person’s repayment amount can change with a few simple tax filing and debt structure changes.  The chart below provides a summary of only three options.

This is a married couple who currently both have federal loans. Spouse 1 has just over $65K of federal student loans and has an income of $50K.  Spouse 2 qualified for Public Loan Forgiveness and has just over $97K of federal loans and an income of $60K.  Both contribute to their company’s retirement plan and have no children or a home.

To keep things simple, we are only going to analyze the changes in the Pay As You Earn (PAYE) method for Spouse 2.

A sample of Married Filing Separately with Student Loans

Filing Separate Chart Comparison

The goal of this chart is to just show you how a few simple decisions can change a couple’s student loan repayment amounts.   By just making combination changes in the tax filing status and the type of loans, the couple could have an addition $264 a month in cash flow for just this borrower.

In column 1 the couple files as married and joint with both having federal loans.  In column 2 they still file married and joint, but Spouse 1 has refinanced their federal loans to a private student loan resulting in an increase of $264 per month for Spouse 2.  As a result of Spouse 1 refinancing, this couple will need to file married and separate which results in a monthly payment of $366 and a tax increase of $61 per month.

You can now see how complex these options are and why couples struggle through the decision process.

Impact of Community Property States on Loan Repayment

For couples who live in community property states, the advantage of filing separately could be a blessing or a curse.  This will depend on who has the higher income and who has the debt.

The community property states are:

  • Arizona
  • California (may apply to domestic partners)
  • Idaho
  • Louisiana
  • Nevada (may apply to domestic partners
  • New Mexico
  • Texas
  • Washington (may apply to domestic partners)
  • Wisconsin

In these states, the income is split 50 – 50 on a tax return if they file married and separate.  This can be maximized when the higher debt person has the highest income.  The higher-income person will get a net reduction which in turn reduces adjusted gross income and their monthly IDR payment.

Marriage Filing Decision 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.  For couples, it is critical to understand the tax differential and then compare it to your student loan repayment options. These decisions become even more important as your financial life becomes more complex with home purchases and adding children.

There is some good news for the recently married couple and engaged couples.  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 year-end approaches, this may be a good time to do some additional planning.  Having a discussion and a plan on money and specifically, student loans may be a great idea.

Disclaimer: PayForED is not a tax consulting firm.  Any of the above information needs to be reviewed by a tax advisor since other tax items could impact your results.



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