The Right Filing Status Can Pay Off Big Time on Your Taxes

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Tax season is in the home stretch, and millions of Americans are working hard to get their tax returns in by the April 15 deadline. Yet even as you focus on getting the numbers right and looking for strategies to make the most of available tax breaks, many people never really think about the importance of one essential component of their returns: which tax filing status they claim.

At first glance, your tax filing status might seem more like a piece of personal information than a key part of your tax planning. Yet filing status can make a huge impact on how much you owe. Let's take a closer look at your tax filing status and why it matters so much.

Tax Filing Status: What the Options Are

Taxpayers have five filing statuses that can apply to their personal situation. Two of the options cover most people who aren't married, while two more apply for most married couples, and the fifth deals with those whose spouse has recently died.

Those who aren't married as of the last day of the tax year typically file either as Single or as Head of Household. The Head of Household status is available to those who pay more than half the cost of keeping up a home for a qualifying child or other eligible relative. Typically, the child must be 18 or younger and live with you for more than half the year. Full-time students who are 24 or younger can also qualify. Other relatives must have limited income and either live with you more than half the year or be eligible for you to claim as an exemption on your tax return. If you don't qualify as a Head of Household, then you'll typically need to file as a Single taxpayer.

Married taxpayers can typically choose to file jointly or separately. Married Filing Jointly status involves adding up income and deductions and treating the couple as a single economic unit, while Married Filing Separately requires you to split up income and deductions according to state law and by what each spouse actually received and paid.

Widows and widowers have special rules. If your spouse died during the tax year, then you're allowed to file a return for that year under Married Filing Jointly status. Furthermore, if you have a dependent child and your spouse died within the two preceding tax years, then you can use the Qualifying Widow(er) With Dependent Child status.

The Big Difference Tax Filing Status Makes

The reason that tax filing status is so important is that nearly everything about your tax liability depends on it. The impact of qualifying for a different status can dramatically reduce your tax bill. For instance, having Head of Household status has many advantages over Single status. Using 2014 figures as examples:
  • Your standard deduction of $9,100 is $2,900 higher than Single filers.
  • Your tax brackets extend higher, letting more of your income get taxed at lower rates. For example, Single filers have to pay a 25 percent marginal rate starting at $36,900 in taxable income. Head of Household filers pay 15 percent all the way up to $49,400, allowing you to save as much as $1,250 in taxes compared to Single filers.
  • Wider tax brackets also give Head of Household filers more opportunity to take advantage of lower maximum tax rates on long-term capital gains and dividend income, with the 0 percent rate extending $12,500 higher and the 15 percent maximum applying until income reaches $432,200, $25,450 higher than for Single filers.
For widows and widowers, the differences can be even more extreme. Without Qualifying Widow(er) status, Single or Head of Household status would provide much lower standard deductions than the $12,400 that applies. Essentially, Qualifying Widow(er) status is equivalent to Married Filing Jointly for couples, featuring tax brackets that in some cases are twice as wide as those that Single filers have.

Finally, some tax breaks simply aren't available to those in certain tax filing statuses. Married Filing Separately taxpayers take the biggest hit here, as they don't qualify at all for the Earned Income Tax Credit, the Child and Dependent Care Credit, and several education provisions including the American Opportunity and Lifetime Learning credits. Higher income thresholds for joint filers can allow some people who file as Married Filing Jointly to take deductions or credits that they wouldn't qualify to receive if they filed as Married Filing Separately.

Motley Fool contributor Dan Caplinger thinks social media outlets should replace "relationship status" updates with tax filing status updates. You can follow him on Twitter @DanCaplinger or on Google+. Check out our free report on one great stock to buy for 2015 and beyond.
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