Tax Strategies for Unmarried Couples

Typically, married couples pay lower taxes if they file joint returns rather than filing separately. However, if a couple is living together but not married, the two taxpayers can’t file jointly.
Nevertheless, there are ways for unmarried cohabitants to reduce the household’s income tax bill. Determining the deductions The higher your tax bracket, the more tax you’ll save from a deduction that reduces your income.

Example: Alice Johnson expects to have around $200,000 in taxable income this year, which will put her in a 33% federal tax bracket. She lives with Richard Smith, who expects to have taxable income of $50,000, which will put him in the 25% tax bracket.

This couple decides to contribute $1,000 to their favorite charity. If Alice writes the check, she’ll reduce her taxable income by $1,000 and save $330 in tax, at a 33% rate. If Richard writes a $1,000 check, he’ll save only $250. Therefore, it makes sense for Alice to make the couple’s charitable donations.
Similarly, if this couple uses a mortgage to buy a home, Alice should write the checks to take the deduction at her tax rate. If they take out the mortgage loan together, it is a good idea for Alice to contact the lender to make sure that her Social Security number is on the report of mortgage interest that it files with the IRS.

Alternative solutions
In keeping with the previous example, in most cases Alice should also pay the real estate property tax to get the deduction in her higher tax bracket. However, Alice may find herself subject to the alternative minimum tax (AMT). Many moderate income and high income taxpayers owe the AMT if they use certain tax credits and deductions. Taxpayers who are subject to the AMT are allowed no federal tax deductions for state or local tax payments. As long as Richard is a co-owner of the house and not subject to the AMT, he can pay the property tax bills and take deductions to cut his federal income tax.

Richard also should pay for items that qualify as miscellaneous itemized deductions, such as investment publications and tax preparation software. Miscellaneous deductions
only save tax to the extent that they exceed 2% of your adjusted gross income, and Richard is more likely to clear that hurdle than Alice.

Capital idea
For some unmarried couples, income differences may be even greater than they are for Alice and Richard. One partner may earn income while the other stays home to manage the household. In such situations, the high bracket partner might transfer appreciated assets to the low bracket partner before an intended sale. As long as the low bracket partner has taxable income of no more than $34,000 (in 2010), any gains on assets with a holding period longer than one year will not be taxed.

Transfers of assets between unmarried partners may have gift and estate tax consequences. Our office can help with those issues as well as other tax matters that may arise for unmarried couples.