Tony Nitti for Forbes writes: Earlier today, the Supreme Court ruled a key component of the Defense of Marriage Act (DOMA) unconstitutional, capping what Time Magazine is calling “one of the fastest civil rights shifts in the nation’s history.”
Understand this, however: the Court’s decision does not pave the way for same-sex couples to get married with impunity. Rather, by striking down DOMA, the Court has simply ordered the federal government to leave the definition of a “marriage” to the States. In other words, if a couple is recognized as married by one of the 12 states that currently permit same-sex marriages, the federal government no longer has the ability to trump that treatment by defining marriage as only between a man and woman, thereby denying the couple benefits under nearly 1,000 federal statutes.
The Supreme Court’s ruling is clearly a victory for equality. And from a tax perspective, the decision stands to save meaningful dollars for same-sex couples who will now be defined as married for purposes of the federal estate and gift laws; because the marital deduction will now apply to these couples, spouses will be permitted to transfer assets to each other tax-free during their lifetime or at death.
In addition, now that DOMA can no longer dictate whether a couple is considered “married” for federal law purposes, same-sex couples who are respected as married under State law should be permitted to file a joint federal tax return. And when the smoke clears, my guess is that these same couples will certainly be permitted to go back to any year still open under the statute of limitations — typically three years — and amend a previously filed tax return as a married couple.
But here’s the thing: while my intention is not to rain on the celebratory parade of those same-sex couples that have long awaited this day, I’d be remiss if I didn’t point out that under the current iteration of the tax law, being considered married ain’t all it’s cracked up to be.
The “marriage penalty” has long been a hallmark of this country’s tax regime; in its simplest form, this term refers to the fact that higher tax rates do not kick in at amounts that are exactly double those of single taxpayers. For example, in 2013 a single taxpayer will begin paying a marginal tax rate of 33% once taxable income exceeds $183,251. Married taxpayers, however, will begin paying a 33% rate once taxable income exceeds only $223,051, an amount only $40,000 higher than single taxpayers. Hence, the marriage penalty.
Beginning in 2013, however, the marriage penalty takes on even greater importance. Courtesy of three recent changes to the tax law, married taxpayers are now getting the shaft relative to their single peers even more than they previously were.
Law Change #1: Obamacare
Starting in 2013, the Patient Protection and Affordable Care Act – or less formally, Obamacare – will impose two additional taxes of note:
1. An additional 0.9% Medicare tax on wages and self-employment income in excess of the applicable threshold, and
2. An additional 3.8% tax on a taxpayer’s net investment income when adjusted gross income exceeds certain thresholds.
But here’s the catch: the threshold in both cases is $200,000 for a single taxpayer, but only $250,000 for a married taxpayer. To illustrate the inequity this causes, consider the following example:
In 2013, Ace and Gary, two single taxpayers, each earn $150,000 in wages and $50,000 in dividend income. If they remain single, neither Ace nor Gary will be subject to either of the two Obamacare taxes, as they have neither wage income nor adjusted gross income in excess of the applicable $200,000 threshold.
If instead, Ace and Gary get married under the laws of New York and file a joint return for 2013, the fact that the Obamacare thresholds for married taxpayers are not double those of single taxpayers will cause the tax increases to take hold. Because their total wage income of $300,000 exceeds the applicable $250,000 limit, Ace and Gary will pay an additional 0.9% tax on $50,000 of wage income. In addition, because their adjusted gross income ($400,000) exceeds the applicable threshold ($250,000) by $150,000, Ace and Gary will also pay an extra 3.8% tax on their $100,000 of net investment income.
Law Change #2: Maximum Tax Rates Under the Fiscal Cliff Deal
For the top 1% of taxpayers, 2013 brings an increase in the maximum rate on ordinary income from 35% to 39.6%, while the top rate on long-term capital gains and qualified dividends has increased from 15% to 20%.
Once again, the threshold at which these higher rates kick in does not favor the married. Single taxpayers will pay tax at 39.6% on all taxable income in excess of $400,000, while married taxpayers will begin paying the higher rate on all taxable income in excess of $450,000; a mere $50,000 increase over their single counterparts. Similarly, the maximum tax rate on long-term capital gains and qualified dividends jumps from 15% to 20% at these same thresholds.
Example: Rocky and Apollo each earn $300,000 of wage income and $50,000 of dividend income during 2013. Had they remained single, Rocky and Apollo would each pay tax on their ordinary income at a maximum rate of 33%, and all of their dividend income would be taxed at 15%.
If, however, Rocky and Apollo marry on December 31st, 2013 and elect to file a joint return, the damage is significant. The joint return will reflect $600,000 of wage income and $100,000 of dividend income. As a result, $150,000 ($600,000-$450,000) of their ordinary income will now be taxed at a maximum of 39.6%, and the entire $100,000 of dividend income will be taxed at 20% rather than 15%. And of course, don’t forget to tack on the additional 0.9% Medicare tax on $350,000 of wages ($600,000 – $250,000) and an extra 3.8% on the net investment income of $100,000!
Law Change #3: PEP and PEASE Is Back
In the year-end fiscal cliff deal, Congress resuscitated the limitation on the personal exemptions and itemized deductions of certain high-earners. Starting in 2013, as adjusted gross income exceeds certain thresholds, taxpayers stand to lose as much as 80% of their itemized deductions and all of their personal exemptions.
As we saw in the previous two examples, this threshold is not doubled for married taxpayers; rather, a single taxpayer will be subject to these phase-outs once adjusted gross income exceeds $250,000, while married taxpayers will lose tax benefits once adjusted gross income exceeds $300,000.
Now, you may say, “Just because we’re married doesn’t mean we have to file jointly. Why can’t we just file separately?” Unfortunately, married taxpayers who file separately do not default to the “single” thresholds; rather, the threshold for each of the three law changes becomes exactly half of the married threshold: $125,000 for the Obamacare taxes, $225,000 for the tax rates, and $150,000 for PEP and PEASE. This only exacerbates the marriage penalty.
So congratulations, same-sex couples. Now you get to be abused by the tax law, just like the rest of us!
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