Tax Tip of the Month
The so-called “marriage tax penalty” was eliminated in large part due to the Tax Reform coming into effect in 2017. However, significant modifications remain when comparing the tax burden of a married couple versus two single taxpayers.
One rule of thumb is when both spouses have about the same taxable income - their combined income tax is typically more than had they stayed single. On the flip side, when one spouse has significantly more taxable income than the other spouse, then often their combined income tax is less than if they had stayed single.
Weddings near the end of the year might not be the best idea from our experience with clients these past few tax seasons. More times than not, had the couple waited just a few days until after the 1st of the year, significant tax dollars may have been saved. It is difficult explaining to a newlywed couple who both received refunds as single taxpayers for the prior year; yet, now have a tax liability as a married couple.
Over two million American couples will get married this year. Many of them will pay more in taxes due to tying the knot.
The passing of the Trump Administration’s “Tax Cut and Jobs Act” in 2017 lowered the cost of being married for many couples. Even so, being married is often more expensive than being two single filers come tax time. If a couple has children and both spouses earn income, they can owe Mister Uncle Sam thousands of dollars every year just for being married.
These marriage “disincentives,” as some will call it, prompt some devoted couples to leave the knot untied until it is advantageous to do so. Some even have big weddings but don’t marry legally.
While most couples choose to keep this decision private, or within close family, one well-known economist duo has been unsurprisingly open about the decision.
The economists have been together for years. They are the parents of two children. Yet, they aren’t married and say one large reason is due to taxes. Filing as two single people provides the couple with significant tax savings, according to the wife, though she declined to say how much.
By being public, the couple hopes to stimulate policy discussion.
Here’s how marriage bonuses and penalties work in practice, based on examples computed on the Tax Policy Center’s 2019 Marriage Calculator. It’s free and useful for what-if calculations.
Many tax provisions penalize married joint filers because the benefit for them isn’t twice the amount that single filers receive.
Maximum deduction for student-loan interest
Single $2,500 Joint $2,500
Maximum capital losses deductible from ordinary income
Single $3,000 Joint $3,000
Maximum deduction for state and local taxes
Single $10,000 Joint $10,000
Traditional IRA deduction disallowance begins
Single $64,000 Joint $103,000
Roth IRA contribution disallowance begins
Single $122,000 Joint $193,000
3.8% tax on net investment income begins
Single $200,000 Joint $250,000
Additional 0.9% Medicare tax on wages begins
Single $200,000 Joint $250,000
20% rate on certain capital gains and dividends begins
Single $434,550 Joint $488,850
37% rate on taxable income begins
Single $510,300 Joint $612,350
Mortgage debt eligible for interest deduction
Single $750,000 Joint $750,000
For illustration purposes, let’s say two couples each have total income of $225,000 and no children or itemized deductions.
In the first couple, one partner earns $210,000 and one earns $15,000. If they marry, they’ll save about $8,400 compared with filing as two singles.
In the second couple, one partner earns $145,000 and the other earns $80,000. Being married will save them about $300 compared with filing as two singles.
Things change if each couple has two young children and typical deductions for mortgage interest, state taxes and charity. The couple with one high and one low earner has a marriage bonus, although it drops to about $3,200.
The second couple now has a big marriage penalty.
They owe about $4,000 more than they’d pay as two single filers—just for one year. Having a $50,000 capital-gain windfall would add nearly $1,000 to their penalty.
The reasons for these disparities are complex. One economist explains that in a system that imposes higher rates as income rises, like America’s, it’s impossible to tax married couples based on their total income regardless of who earns it while also taxing married couples so they owe the same as two single people.
The U.S. system creates marriage bonuses and penalties. Other countries avoid this by taxing married couples as two individuals. Shifting to such a system could be difficult in the U.S., in part because of community-property laws in some states.
The tax code also has marriage penalties in specific provisions.
For example, singles can’t directly contribute the maximum amount to a Roth IRA for 2019 if they earn more than $122,000. For married couples the limit is $193,000—not $244,000.
The 2017 tax reform repealed some marriage penalties and broadened some tax brackets, helping many two-earner married couples. But it retained other marriage penalties and added more.
One is the new $10,000 limit on deductions for state and local taxes, or SALT. This especially affects the Democratic states, namely California and New York. This limit is per return, so married joint filers who list deductions on Schedule A get only a $10,000 write-off, while two single filers living together get a $20,000 write-off.
Affluent married couples hoping to buy a home in expensive areas like Los Angeles or Manhattan could also feel the sting. The Tax Reform dropped the maximum mortgage debt that’s eligible for an interest deduction on new purchases to $750,000 from about $1 million, and the limit is per return.
So an unmarried couple can deduct interest on $1.5 million of mortgage debt, while the limit for a married couple is $750,000. Yet another argument in considering whether it is more beneficial financially to stay single for tax purposes.
For couples contemplating marriage, estimating the tax cost can be difficult and, at least partially, subjective. One reason being that marriage penalties often vary over time. For example, a two-earner couple may not owe a penalty when they are first married. If they become a one-earner couple when they have children, they may get a marriage bonus.
If both spouses work and prosper, however, their penalty could grow. Laws can and will change. Marriage penalties removed by the 2017 Tax Return will return after 2025 if Congress doesn’t oppose to this.
Yet another complication is that the U.S. tax code provides marriage bonuses, even to couples who owe marriage penalties. For example, a spouse who inherits a traditional IRA or 401(k) account has better options than a non-spouse heir.
Unmarried couples face other costs and issues, of course. They may pay more for health coverage, and they have to prepare two tax returns. They’ll need to take special care with health proxies, powers of attorney and other legal documents giving them decision-making powers over each other and children.
Married couples who currently owe penalties have options for lowering them, but not many. One is to reduce reported income where possible, say by contributing to tax-deductible retirement plans or spreading taxable capital gains over more than one year.
Also consider the “married, filing separately” status. This choice doesn’t allow couples to file as two singles, and it usually raises taxes. But sometimes it lowers them, as when one partner has a small business that qualifies for a 20% deduction if a higher-earning spouse’s income is excluded. It could also help if one partner has high medical expenses.
How about the other side - getting divorced? This is a lot harder, and has even more tax implications, than getting married. Unfortunately, the Internal Revenue Service for decades has had the utmost discretion to disregard divorces that are solely for tax reasons.
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Any financial or tax information contained in this article is taken from a general view and should not be acted upon in your specific circumstances without further details and analysis of the situation or professional assistance from a CPA or tax return preparer.
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