Can Your Spouse's Defaulted Student Loans Impact Your Tax Return?
Love may allow a spouse to turn a blind eye towards his or her partner's defaulted federal student loans, but the IRS won't be so forgiving. It's likely the offending spouse will get his or her tax return garnished by the federal government to repay the debt, but there's more. Uncle Sam may swoop in to intercept the tax returns owed to both spouses if the married couple files taxes jointly.
How Can the IRS Do That?
Being married and filing a joint tax return makes it perfectly legal, and frankly probable, that both spouses will see their tax returns intercepted. After all, those loans are funded by the federal government, so tax time is an easy way for the IRS to work as a collections agency.
This shouldn't be a shock, since the spouse with defaulted student loans likely received advance notice that a tax refund garnishment was possible. Let's just hope this little fact is disclosed before the IRS steps in to claim repayment for student loans. Otherwise couples counseling might be an additional cost of tax season!
One way to avoid the frustration of seeing a tax return vanish to repay a spouse's debt is to file separately. Just keep in mind this requires both partners to itemize their tax returns in order to claim their allowable deductions.
Unfortunately, even student loans in good standing could get messed with come tax time.
The Other Student-Loan Issue With Being Married and Filing Jointly
Filing jointly can also have hefty financial consequences for those making student loan payments using an income-driven repayment plan.
Income-driven repayment plans cap monthly student loan payments at a percentage of discretionary income. The percentage varies from 10 to 20 percent depending on the plan. When a couple files a tax return jointly, the monthly payment can spike because the payment is no longer based on 10 percent of the original borrower's income, but rather at 10 percent of the couple's discretionary income.
This can be a financially devastating mistake for the monthly budget, which is why filing jointly may not be the way to go.
"While every situation is different, filing separately is more likely to make sense if you have a large amount of student loan debt compared to your income and your spouse has a small amount of debt compared to his or her income," explains Matt Becker, fee-only financial planner and founder of Mom and Dad Money, a financial planning practice. "And it's even more likely to help if you qualify for public service loan forgiveness, since the benefits of forgiveness under that program are so great."
How to Get Your Money Back
Becker notes that all is not lost for those who filed a joint tax return without realizing it would spike student loan payments.
"You can file an amended tax return to update your filing status and then re-apply for income-driven repayment," says Becker. He recommends doing this before April 15, or in the case of 2016, April 18, to avoid any penalties or interest on extra tax payments the applicant may have to make.
Those who lost money due to filing jointly with a spouse who defaulted on student loans can submit an injured spouse claim with Form 8379. This claim is only justified if the injured spouse is not legally responsible for the debt (usually the case if it was brought into the marriage).
But Filing Jointly Still Might Make More Sense
Even if filing jointly could bump up your monthly student loan payment or cause your refund to get intercepted, it still might make more sense in the long run.
Filing separately means potentially losing out or minimizing the impact of helpful tax credits and deductions, including, but not limited to, the earned income tax credit, child and dependent care tax credit, credit for the elderly and disabled, deduction for college tuition expenses, student loan interest deduction, the American opportunity credit and the lifetime learning credit for higher education expenses.
This is why it's important to run the numbers before formally hitting submit on a tax return, which can be done by using online tools like TurboTax's TaxCaster.
Erin Lowry writes about personal finance and serves as the content director for MagnifyMoney.com, a site dedicated to helping consumers save money by finding simple and transparent financial products. She is also the founder of the personal finance blog Broke Millennial.
