By Dr. James M. Dahle, WCI Founder
There are nine community property states in the United States of America. They are:
- Arizona
- California
- Idaho
- Louisiana
- Nevada
- New Mexico
- Texas
- Washington
- Wisconsin
What Is a Community Property State?
What do most of these states have in common? This map will demonstrate it well.
As you can see, all of those states (with the possible exception of Wisconsin, which was awfully close) were part of New Spain, aka Mexico, and brought some of the customs of Spanish/French (civil) law rather than English (common) law into their state constitutions. Under civil law, spouses were considered to be equal economic partners, it was an “amoral business relationship”. Assets and income acquired during the marriage belong equally to both partners. Under common law, a man has a “deeply rooted moral obligation to support his wife and children”, but basically assets or income acquired during a marriage belong to the person (historically the man) who acquired them.
History lesson over, but the modern-day ramifications of all that history are that when you file your taxes as Married Filing Separately (MFS) in one of those community property states, you split your income 50/50, no matter who earned the income. This has serious ramifications on the federal Income-Driven Repayment (IDR) and Public Service Loan Forgiveness (PSLF) programs.
Married Filing Separately Loan Strategies
As you may or may not recall, the most complicated student loan strategies involve married couples where one or both partners are going for some type of student loan forgiveness. Sometimes it makes sense for these partners to enroll in PAYE (not REPAYE, which looks at both spouse's income) and to file their taxes MFS, even if it increases their tax bill somewhat (as it often does, especially if their incomes are unequal) in order to have lower IDR payments and thus have more of the loan left to be forgiven.
The reason these strategies typically work is that your payments are only based on your income and maybe your income is lower than your spouse's. To learn about MFS strategies in-depth, see the article, How Does Married Filing Separately Affect Student Loans by Andrew Paulson, CSLP and Lead Student Loan Consultant at StudentLoanAdvice.com.
But in a community property state, splitting your income has the potential to nix the benefit of filing MFS.
Community property status is just one more variable in an already complicated calculus.
Student Loan Tax Benefits of Community Property States
However, there is a situation where being in a community property state makes the MFS/PAYE trick work even better than it usually does. Consider a couple where Jamal is a physician making $300,000 with $500,000 in student loans enrolled in PAYE for the last 5 years and going for PSLF and Latifa is a social worker making $30,000 without any student loans. If they were in Florida, a non-community property state, their numbers would look like this:
Filing MFJ:
- PAYE payment: $2,547 per month ($30,564 per year)
- Tax Bill: $61,407
Filing MFS
- PAYE payment: $2,349 per month ($28,188 per year)
- Tax Bill: $75,455 + $1,915 = $77,370
So filing MFS results in paying $2K less a year in student loan payments, but paying $16K more in taxes. Not a good move.
But what if they lived in Texas, a community property state? Then what would the numbers look like?
Filing MFJ:
- PAYE payment: $2,547 per month ($30,564 per year)
- Tax Bill: $61,407
Filing MFS
- PAYE payment: $1,224 per month ($14,688 per year)
- Tax Bill: $61,407
Now their tax bill is exactly the same whether they file MFJ or MFS, but the PAYE payment drops dramatically. Now they've saved $16K a year. Over the course of the next five years, until Jamal gets PSLF, this couple will save $80K. If he were going for PAYE forgiveness, the difference between Florida and Texas would be three times as great (although some of that would be eliminated as a result of having a larger tax bomb at the end because PAYE forgiveness is taxable).
Tax Implications for Married Couples in Community Property States
Let's take a new married couple in a new situation. We'll call them Julie and Sally. They're both doctors in Washington, but Julie has both the lower income and the higher student loans. She has decided to go for PSLF in 7 more years (she made 3 years of payments in residency). Sally is a high-powered surgeon, but her parents had a big 529, so her loans are much smaller and in fact, she already refinanced them and expects to pay them off this year.
- Julie Income: $180,000
- Julie Federal Loans: $400,000
- Sally Income: $320,000
- Sally Federal Loans: $0
MFJ
- Income: $500,000
- PAYE payment: $4,016 per month ($48,192 per year)
- Tax Bill: $115,910
MFS in Washington
- Income: $180,000 + $320,000 = $500,000
- PAYE payment: $1,933 per month ($23,196 per year)
- Tax Bill: $115,910
Seems like a big win, right? They're saving $25,000 per year in payments. But what if they moved up to Alaska?
MFS in Florida
- Income: $180,000 + $320,000 = $500,000
- PAYE payment: $1,349 per month ($16,188)
- Tax Bill: $34,648 + $82,455 = 117,103
They pay $2K more in taxes, but save a whopping $32K a year in student loan payments. Add it all up and they're saving $5K a year. Talk about geographic arbitrage.
At any rate, it demonstrates how being in a community property state can hurt you, even if the MFS/PAYE trick still works.
The Paystubs instead of Tax Returns Trick
Another strategy you might consider is to use your paystubs to prove your income instead of your tax returns. That's not going to make much of a difference in a common law state, but in a community property state, it could be much lower income. For example, in the example above if Julie used pay stubs her PAYE payment would be calculated using an income of $180K instead of $250K (50% of their combined income).
What If They Both Have Student Loans?
Even if both members of a couple have federal student loans and are in a community property state, there are still situations where it may be advantageous to use PAYE and file MFS. You just have to run the numbers in these complex situations. You will often find that the MFS/PAYE trick is much more advantageous in a non-community property state than in a community property state, particularly if the lower earner has the largest student loans and is going for forgiveness.
Get Student Loan Advice from an Expert
These student loan scenarios are complicated and being in a community property state might make your calculation more or less complicated than otherwise. If you need help running the numbers, spend an hour with an expert at StudentLoanAdvice.com, a White Coat Investor company. A few hundred dollars now may result in tens of thousands more dollars in forgiveness down the line. Don't be penny wise and pound foolish.
If you're not going to bother going for forgiveness, it's probably time to refinance those student loans. If you go through the links below, you'll get the exact same deal you would get going directly to the lenders plus several hundred dollars in cash back.
† Bonus includes cash rebates and value of free course. Borrowers who refinance more than $60,000 in student loans using the WCI links will be enrolled in The White Coat Investor’s flagship course, Fire Your Financial Advisor for free ($799 value). Borrowers will still receive the amazing cash rebates that WCI has negotiated with each lender. Offer valid for loan applications submitted from May 1, 2021 through October 31, 2023. Free course must be claimed within 90 days of loan disbursement. To claim free course enrollment, visit https://www.whitecoatinvestor.com/RefiBonus.
What do you think? Are you in a community property state? Did it affect your student loan management decision? Why or why not? Comment below!
Worth noting: as far as we understood it- if you’re MAGI is over 10k and you contribute to a Roth IRA, you are ineligible for MFS. We found that out too late.
You’ve got it backwards. If you file MFS, you can’t make a full direct Roth IRA contribution no matter your income. If your MAGI is over $10K, you can’t make any direct Roth IRA contribution at all. But you can still do a Backdoor Roth IRA.
Good to know you can still do the backdoor Roth. Thanks!
Hopefully a bit of constructive criticism as this one seems to not be as crisp of a write-up as I have come to expect here (If I had to guess, I’d probably say that Jim didn’t write this). Hopefully later I’ll have more time to complete my thoughts, but…
Here are a couple of spots I had to re-read multiple times because they didn’t make sense to me:
“But in a community property state, splitting your income can essentially nix any benefit of filing MFS.” I suppose what you mean to state here is that “In a CP state, splitting your income [WHEN YOU ARE THE LOAN HOLDER AND THE LOWER INCOME EARNER] can essentially nix benefit…
Presumably, that’s what you meant in this section per the sentences prior. However, that’s not totally true either. You do NOT have to verify your income only based on tax returns. if you are the lower earner, you can submit your paystub (granted at GROSS not NET income).
The second bizarre scenario is the comment on Alaska – point taken (though again, if you are ignoring alternate income verification, that’s weird), but also Alaska/Hawaii has completely different poverty levels, thus causing a completely different calculation for IDRs. I’m not doing the math, but that’s probably important to note that it’s literally a different math calculation, not a tax problem.
Appreciate the feedback. I think I have it fixed now.
Good point on the fact that the calculation is different in Alaska (and Hawaii). I was just trying to choose a common law state without a state income tax and compare to a community property state without a state income tax. Probably should have chosen Florida instead. I’ll change it.
And yes, I did write it, although we have made some changes to the editorial team which may have been what you detected, dunno.
In some of those states I believe Julie and Sally couldn’t be legally married so I’m not sure they’d file that way anyway. I believe Texas at least might still prohibit it?
I don’t know the ins and outs of a specific states laws, but this stuff is based on federal returns and federal law recognizes same sex marriage so I’d be shocked if above scenario came into play.
Obergefell v Hodges anyone?
https://en.wikipedia.org/wiki/Obergefell_v._Hodges
East Coast,
Thanks for the feedback. The part on community property states will be fixed.
For clarification – Married filing separately in a community property state CAN be advantageous for student loan borrowers. And, in some cases might lower their payment even more than if they were living in a common law state.
To see a deeper analysis on this, check out this recent post:
https://www.whitecoatinvestor.com/student-loans-and-filing-status/
The post mentioned that PAYE loan forgiveness is taxable. I thought that PSLF loan forgiveness was not taxed. (https://studentaid.gov/manage-loans/forgiveness-cancellation/public-service/questions). Can anyone confirm or deny if PSLF loan forgiveness on PAYE is taxable?
That’s correct. PSLF at 10 years is tax-free. IBR/PAYE/REPAYE forgiveness at 20-25 years is taxable.
Hi Pete,
PAYE forgiveness as discussed in the article is Income Driven Repayment (IDR) forgiveness in PAYE which is granted after 20 years of payments. This doesn’t require:
-501c3 or non-profit employment
-full-time work
-employment certification forms (PSLF annual cert form)
Like PSLF does.
And it actually isn’t taxable if you were to reach 20 years of payments in before Jan 1, 2026. However, this law sunsets on Jan 1 2026, so most of you will be on the hook for taxes (tax bomb) on the remaining debt balance if you pursue this type of forgiveness.
Article for reference: https://www.forbes.com/sites/adamminsky/2021/03/07/congress-makes-big-change-to-income-based-repayment-what-student-loan-borrowers-should-know/?sh=648fee0334e2
Enrolling in PAYE and completing the requirements for PSLF is not taxable.
The distinction here is IDR and Loan Forgiveness are separate things but can be combined.
Hi Pete,
PAYE forgiveness as discussed in the post is Income Driven Repayment (IDR) forgiveness in PAYE which is granted after 20 years of payments. This doesn’t require:
-501c3 or non-profit employment
-full-time work
-employment certification forms (PSLF annual cert form)
Like PSLF does.
And it actually isn’t taxable if you were to reach 20 years of payments in before Jan 1, 2026. However, this law sunsets on Jan 1 2026, so most of you will be on the hook for taxes (tax bomb) on the remaining debt balance if you pursue this type of forgiveness.
Article for reference: https://www.forbes.com/sites/adamminsky/2021/03/07/congress-makes-big-change-to-income-based-repayment-what-student-loan-borrowers-should-know/?sh=648fee0334e2
Enrolling in PAYE and completing the requirements for PSLF is not taxable.
The distinction here is IDR and PSLF are separate things but can be combined.