PSA: The Breadwinner Loophole

This applies to married folks who:

1. Live in a community property state (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin)
2. One partner (the breadwinner) makes significantly more than the other partner
3. The breadwinner has a large amount of student loans, while the other partner has no student loans (of very small loans)

This can potentially lead to a beneficial situation where the breadwinner's AGI is lower than it would be if filing jointly or filing separately in a non-community state.

The benefit of filing MFS in a community property state is greatest when the spouse with the student loans also has the greater income and is on an Income Driven plan. Say Ray has student loans of $50k, and makes $105k a year. His spouse Charlie makes $70k, but has no loans. In a community property state all the income and withholding are split equally among the spouses which means that as far as the IRS is concerned, Ray's income is $87,500 and Charlie's income is $87,500. So:

• File jointly: Ray's AGI is based on $175k/year
• File Separately in a non-community property state: Ray's AGI is based on $105k/year
• File Separately in a Community Property state: Ray's AGI is based on $87.5k/year

Ray's payments could be significantly smaller filing separately in a community property state. This is called the breadwinner loophole.

As for how to file. I tried in 3 different tax preparation programs, and unfortunately TurboTax worked best for me. However the procedure is hacky and frustrating.

Ray prepares his taxes by:

Entering 2 W-2's into Turbo Tax: Both in Ray's name. However one is for Ray's job and one is for Charlie's. For his own W-2, Ray fills it out as normal, but for Box 1 he enters $52,500 (1/2 of his income). Similarly, for Box 2, withholding, he enters 1/2 of the amount given on the form his employer supplied.

For the W-2 for Charlie's job, Ray enters $35,000 for Box 1 and 1/2 of Charlie's withholding in box 2. Leave everything else blank on this W-2. And remember that this W-2 should also be entered in Ray's name.

Charlie enters his W-2s the exact same way, filling out both in his own name, Halving boxes 1 and 2 and leaving everything else blank on the W-2 for Ray's job.

This is incredibly stupid but it is the only way (I have found) to get it done and still be able to E-file.

Note also that you will have to halve any other community income on the relevant forms like 1099's, etc. You'll also need to consider how you split up things like Mortgage Interest deductions and property taxes. I did 50/50 as everything is jointly owned. This actually worked out really well for me.

Now, for form 8958: This is how you inform the IRS what is going on with your messed up W-2s. In tax-preparation software this is usually a dumb form that doesn't feed any information to anywhere else. This is just an accounting ledger so you can show the IRS how you are splitting up income. For each job or other source of Community income, you enter the total amount (the actual value in Box 1 on your W-2s) and then under the column for each spouse you enter half the total amount. That should match what you actually entered in Box 1 on each W-2.

You'll do the same for the withholding. This way you can each claim half of the total withholding and not get set up with a weird situation where one spouse owes thousands of dollars while one gets a refund of thousands of dollars.

Anyway, remember that it's companies like Intuit that are the reason this is all so jacked up.