Income Tax Challenges When You Live Together But Aren’t Married

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Taxes Can Get Interesting When You Can't File Joint Married Returns

The popularity of marriage seems to be waning, at least statistically. According to data released by the U.S. Census Bureau, the number of American adults who were cohabiting without a marriage license increased by 29 percent from 2007 to 2016. Avoidance of matrimony presents some interesting tax challenges, but some strategies can put cohabiting partners on equal or better footing than their married counterparts.

Head of Household Filing Status

Head of household filing status can provide a real tax break if you qualify for it. Your standard deduction is more, and tax brackets shift to allow you to earn more income before you have to pay an increased percentage in taxes.

The good news for unmarried couples is that this is one area in which tax law really favors single folks. One of the rules for claiming head of household status is that you cannot be married. The bad news is that only one adult can claim this filing status per household, and it’s the one who pays for more than half the household’s expenses. He must also have a dependent.

If you and your partner didn’t live together, if you each had a dependent and if you each paid the bills to maintain your separate households, you’d receive a total of $18,700 in standard deductions for the 2017 tax year – one $9,350 head of household standard deduction for each of you. That drops to $15,700 if you live together because one of you would have to file as a single taxpayer instead, a pretty significant difference of $3,000. The standard deduction for a single filer is only $6,350 as of 2017.

You’ll still come out ahead of married couples, however, because the standard deduction for those who file joint returns is $12,700. That’s another $3,000 you’d have to pay taxes on if you tied the knot. Even if you filed separate married returns, you’d still only get the standard deduction of $6,350 each, which amounts to the same thing.

Claiming Dependents

Now, about that dependent you need to qualify as head of household. What if neither of you has a child? There’s an outside chance that one of you could claim the other as a dependent, something else that spouses can’t do. You can claim a personal exemption for your spouse if you file jointly, but she can’t be your dependent, and several tax perks, including head of household status, depend upon having at least one dependent.

Your unmarried partner can be your dependent if she lives with you all year and you pay for more than half her support needs. Her income cannot be more than the year’s personal exemption amount, which is $4,050 as of the 2017 tax year. This does not include Social Security income or public assistance she might receive, however.

If you can meet all these rules, you can shave another $4,050 off your taxable income by claiming a personal exemption for her.

What If You Have a Child Together?

If you and your partner have a child together, this presents another wrinkle. Two unmarried parents cannot both claim their child as their dependent on separate tax returns, and the parent who does so is the one who can become eligible for head of household filing status.

The Internal Revenue Service has tiebreaker rules that determine which parent can claim a child when they’re not married and can’t file a joint return. The first rule gives the child’s personal exemption to the parent with whom he lives most during the year. But that’s both of you if you all live together, so the next tiebreaker rule kicks in to decide the matter.

The dependent deduction/personal exemption goes to the parent with the highest adjusted gross income when the child lives with each of them the same amount of time.

Of course, these rules come into play only if you can’t agree on which of you claims your child as his dependent, and the IRS therefore gets involved in the dispute. And this would typically only happen if you both tried to claim the child on separate returns.

Otherwise, you’re free to decide between you who will claim the deduction, and you can use this to your best advantage. It would typically do more good for the parent with the most income to claim the child if that parent is in a higher tax bracket and therefore paying a greater percentage to the IRS.

The Capital Gains Exclusion on a Primary Residence

Unfortunately, the news for unmarried filers begins to go downhill from here.

One tax break that married couples are entitled to is the capital gains exclusion if they sell their primary residence for a profit, and it’s a whopper: $500,000. When a married couple sells their home, they don’t have to pay capital gains tax until they realize a $500,001 profit between the property’s tax basis and the selling price. Even then, they’d pay capital gains tax only on that one dollar, because the first $500,000 is exempt.

The exemption drops by half, down to $250,000, if you’re not married. But it's sometimes possible to work around this rule and claim the entire $500,000 exemption even without a marriage license.

You can each claim a $250,000 exemption if you own the home together and you sell it for a profit, as long as each of you legally owns the property and each of you lived there for at least two of the five years immediately preceding the sale. The two years of residency don’t have to be concurrent, but both of you must be on the deed to the property and hold ownership for five years. Otherwise, the one who owns the property can shelter only a $250,000 gain.

So if you're thinking of selling your property, make sure you're both on the deed, wait through the five-year ownership period and make sure you each live there for at least two of those years.

Then There’s the Matter of Health Insurance

Health insurance companies have caught up with the times in recent years and many allow you to extend coverage to an unmarried domestic partner just as they allow spousal coverage. But the IRS tax code is still in the dark ages. Although the IRS doesn’t tax health benefits that you or your spouse receive from your employer, it does tax the portion of benefits that cover an unmarried partner.

This means that if your partner is covered on your employer-sponsored health plan and his share of the premiums is $7,500 a year, that’s $7,500 more in income that you’ll have to pay taxes on.

What to do? If he’s eligible for a health plan with his own employer, it obviously makes more sense to keep your policies separate. If he’s not, pull out the calculator to determine if covering him on your policy will end up costing more in taxes than the premiums if he bought his own policy.

Who Takes Tax Deductions?

Although there’s not exactly an “unmarried penalty” when it comes to claiming tax deductions, paying attention to who pays what can help you at tax time if you’re not married and you itemize your deductions. If one of you earns significantly more than the other so she falls into a higher tax bracket, it would do more good for her to pay any tax-deductible expenses that you share.

Of course, this necessitates maintaining separate checking accounts, but doing so can be a good work-around for not being able to claim such expenses jointly. If one of you is in the 33-percent tax bracket and the other is in the 25-percent tax bracket, the deductions will save the most tax dollars if they’re paid for and taken by the higher earner.

But there’s a flip side. Some itemized deductions are subject to income thresholds. You can deduct only the portion that exceeds these limits. It’s 10 percent of your AGI for medical expenses, and miscellaneous expenses are subject to a 2-percent threshold. It makes more sense for the lower earner to pay for and claim these deductions whenever possible because it's much easier to surpass 10 percent of $30,000 than it is to exceed 10 percent of $100,000.

You might want to put investments in the name of the lower earner as well because that partner will pay less in capital gains if you realize a profit. In any case, be very sure to keep meticulous records: separate accounts and receipts that lay out a clear paper trail as to who paid for what, and clear ownership documents.

The New Tax Law

The Tax Cuts and Jobs Act is still winding its way through Congress as of December 2017, and it could throw a monkey wrench into some of these strategies when and if it’s passed.

The bill eliminates the head of household filing status, but it significantly increases standard deductions. It’s expected that itemizing your expenses will lose a lot of its appeal because the new standard deduction could end up being more than the total of all your deductible expenses.

The 10-percent medical expense deduction would drop to 7.5 percent, and this provision would be retroactive to the 2017 tax year. But the bottom line is that most of these tax rules are only guaranteed for 2017. As for 2018, we’ll just have to wait and see.


About the Author

Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.