With the passage of the Tax Cuts and Jobs Act of 2017 that eliminated the “marriage penalty” tax brackets, filing a joint federal tax return has mainly become a foregone conclusion for married couples. Under certain circumstances, couples may still opt to file separately. Reasons for filing separately include a pending divorce, separation, repayment of income-based student loans, state community property laws, or avoidance of “joint and several liability.” However, this article will focus on another consideration: the so-called millionaire’s tax provisions enacted by certain states.

As of this writing, six states and the District of Columbia have adopted surtaxes on high-income taxpayers whose taxable income exceeds certain thresholds. The most recent addition to the list is Massachusetts, where, in the November 2022 midterm elections, residents narrowly voted in favor of a 4% surtax on taxable income exceeding $1 million. Other states with a millionaire’s tax include California,
Connecticut, Maine, New Jersey and New York. Each state (and district) has its own variation of the surtax, so for our purposes, we will focus on New York and Massachusetts to highlight potential benefits of filing separately.

Most states require that taxpayers file using the same state return filing status as used for their federal return. (See state-by-state reference chart at the end of this article.) In the following, we highlight two tax planning scenarios—one for New York and one for Massachusetts. New York requires that the federal and state filing status match, while Massachusetts does not.

New York Example

New York imposes a 10.3% tax on taxable income exceeding $5 million and up to $25 million. In other words, for every dollar over $5 million, tax is calculated at 10.3 cents. In the following simplified example, consider a married couple with a combined income of $6 million, earning $3 million each. Assume they are not New York City residents (who pay an additional city tax) and that they have no other income, dependents, credits or itemized deductions. As previously indicated, New York requires that they file a joint state return if they file a joint federal return and vice versa.

In this example, the taxpayers save approximately $38,891 by filing separate federal and New York returns, as individually their income does not surpass the $5 million threshold.

Massachusetts Example

Unlike New York’s graduated tax rates, Massachusetts has traditionally adopted a flat tax of 5% on earned income, interest, dividends and other passive income and a 12% flat tax on short-term capital gains. With the new millionaire’s tax, also called the Fair Share Amendment, an additional 4% of income tax will be imposed on every dollar of taxable income over $1 million. In this example, cons ider a married couple who each earns $900,000 and have no other income, dependents, credits or itemized deductions. Massachusetts allows separate tax returns for couples who file a joint federal return.

In this example, the taxpayers save $32,000 by filing separate Massachusetts returns to avoid the millionaire’s tax that would be applied to their combined income.

Final Thoughts

There are many factors that warrant careful consideration and planning when filing separately. For example, the IRS requires that if one spouse itemizes deductions, then the other spouse must also itemize. Further, the titling of assets such as real estate, bank and investment accounts, rental properties, partnership interests, etc. can and will impact the calculations. Additionally, proper tax planning may also benefit your estate plan.

A new year always brings a new tax season, so be sure to consider all options. Your Cerity Partners advisor can help you determine the best outcome for you.

State by State Filing Status Requirements

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