Laura Saunders for the Wall St Journal writes: Planning on getting married soon? Uncle Sam might be celebrating as well. An inconvenient truth of marriage is that it often brings a tax increase
compared with what the couple would pay as two single people. And the
problem is only getting worse: Provisions taking effect this year will
increase the "marriage penalty" for many high earners.
Just ask Chris Lacerenza and Cara Godsey, who were married in March in Cincinnati. Mr. Lacerenza, a 31-year-old accountant and wealth adviser, and his wife, 30, who sells medical screenings, figure they will owe at least $2,100 in extra federal taxes this year simply because they got married—and that figure likely will rise as they earn more and have children.
Two-earner couples with higher incomes could easily owe a five-figure marriage penalty.
To be sure, not all couples wind up owing more. The current tax system can even produce a marriage bonus if one spouse provides most or all of the income.
For example, a married couple with two teenagers and $150,000 of income, all provided by one partner, would owe nearly $4,600 less than what they would as singles, according to the nonpartisan Tax Policy Center in Washington. In addition, at-home spouses can often contribute to an individual retirement account or Roth IRA.
But a marriage tax bonus can quickly disappear. If just $25,000 of this couple's total $150,000 income is instead earned by the second spouse, says economist Roberton Williams of the Tax Policy Center, the bonus could become a penalty of about $2,000.
There aren't any current data on the size or number of U.S. taxpayers' marriage penalties or bonuses. But according to a U.S. Bureau of Labor Statistics report published this year, the contribution of wives' earnings to overall family income rose to 38% in 2010, up from 27% in 1980. As spousal earnings converge, the likelihood and size of marriage penalties rise.
For example, if the hypothetical spouses cited above each earn $75,000, rather than one partner earning $150,000, they could incur nearly $4,000 more in tax compared with what they would owe as single filers with the same income, deductions and children.
"That's an annual hit," says Randall Smith, a CPA at Samet & Co. in Chestnut Hill, Mass. "None of my clients has ever backed out of a marriage because of the penalty, but people are often surprised by how high it is."
Why do marriage bonuses and penalties exist? "Society has changed, but the tax system is still designed for a world in which one partner works and the other stays home," Mr. Williams says.
Filing a joint tax return means that the second income "stacks" on top of the first, and a married couple can quickly owe more than two singles with the same combined income.
A host of provisions, such as credits and deductions, also phase out for people at higher incomes and help trigger a higher tax bill for two-earner married couples. For example, taxpayer contributions to Roth IRAs are usually curbed beginning at $112,000 for singles but at $178,000 for married couples.
Experts say the largest marriage penalty as a share of income affects low earners who are married with children. Still, the penalty on high-earning couples with two incomes has grown this year. In January lawmakers raised tax rates on ordinary income and capital gains and passed limits on personal exemptions and itemized deductions. There also is a new 3.8% surtax on net investment income, plus a 0.9% increase in payroll tax.
All these increases affect higher-income taxpayers, and in each the threshold for singles is far more generous than the one for married couples. For example, a couple with two teenagers and $500,000 of total earnings, split equally between the two partners, would see their marriage penalty rise from about $15,000 last year to more than $17,000 for 2013, according to the Tax Policy Center.
In general, two-earner couples who make less than $200,000 a year will incur smaller penalties because they aren't subject to the new rates and phase-outs, experts say. More of their income also falls into the first two tax brackets, where the marriage penalty has been eliminated.
"It's a steep price to pay," Mr. Lacerenza says, "but worth every penny, to be married to my best friend."
Because of the tax code's complexity, the marriage penalty or bonus for individual couples will vary widely, especially if they have children. To find out where you stand, check out the calculator posted at taxpolicycenter.org/mpc.
The current provisions are deeply rooted in the tax code and lawmakers would find them expensive to alter, so marriage penalties for two-earner couples will probably last longer than many marriages. Here are strategies that can help lower the bill.
• Reduce reported income.
The marriage penalty can increase with income, especially if a two-earner couple has children and income above $250,000. That means families should make use of strategies that reduce their adjusted gross income, or AGI, which is found at the bottom of the front page of the 1040 form.
Among the items that help on this score are deductible contributions to tax-favored retirement plans, such as 401(k)s, IRAs and pensions, and pretax dollars used to pay for health coverage, a health savings account or a flexible spending account for either health or child-care costs.
Capital losses that are "harvested" can be used to offset future gains, also reducing AGI. Charitable gifts made with assets that have risen in value, which are allowed within certain limits, also can be beneficial when compared with cash gifts.
Although contributions to 529 college-savings plans and Roth IRAs aren't tax-deductible, the income earned on these accounts can be tax-free. Tax-exempt municipal-bond interest doesn't raise AGI, either, although it does count in calculating taxes on Social Security benefits.
However, itemized deductions such as those for mortgage interest, charitable donations, state income and property taxes, and other items from Schedule A, don't help lower your AGI.
• Time income windfalls where possible.
Do you expect a windfall, such as from the sale of a long-held asset? Careful planning—perhaps with expert help—could reduce a marriage penalty and other taxes.
For example, a couple planning to sell appreciated stock to pay tuition might benefit by selling part in December and part in January to lower their reported income.
There is some good news for homeowners: Experts say that in all but a few high-priced real-estate markets, couples selling houses won't see higher taxable income from the sale. The first $500,000 of gain on the sale of a principal residence is tax-free, and the purchase price plus any capital improvements are excluded from the gain.
So if a couple bought a house for $300,000 and did a renovation costing $150,000, then they could sell the house for as much as $950,000 without raising their taxes.
• Consider an IRA charitable rollover.
IRA owners who are 70½ or older should consider using this highly popular technique for donations totaling up to $100,000 a year. It allows the taxpayer to transfer assets directly from the account to a qualified charity such as a church, school or other group. Such donations can count as part of an IRA owner's required annual withdrawal.
Although there isn't any tax deduction, you needn't report any income. If a donation were made in the conventional way—by reporting income and then deducting a donation—adjusted gross income would be higher. By reducing such income, rollovers can help reduce the marriage penalty, as well as income-based Medicare premiums and taxes on Social Security payments.
This tax technique has had a rough ride in recent years, as Congress has let it lapse and then reinstated it only at the last minute. The current version is in effect through the end of 2013.
• Consider filing separately.
Married couples are often surprised to find that they simply can't file as two single people. There is a "married, filing separately" category, but it is set up so that in most cases couples who choose it pay more. "Its main benefit is to sever the legal liability of spouses for a joint return," says David Kautter, a CPA at the Kogod Tax Center at American University.
There are a few exceptions, however. If one spouse has large tax-deductible medical expenses, say from a nursing home, there could be a benefit to filing separately, Mr. Kautter says. More rarely, it could make sense if there is a large casualty loss, such as for a vacation home destroyed by a storm, or a large miscellaneous deduction such as for unreimbursed employee expenses, and the loss or expense is attributable to one spouse.
• Don't get married.
It is a radical move, but some couples choose to opt out.
"Marriage is not the only legitimate outcome for a committed relationship, even one with children," says Cindy Butler, a spokeswoman for the group Unmarried Equality, a Seattle nonprofit that promotes equal financial and legal treatment of single and married people.
She and others caution that couples who choose not to wed should complete legal paperwork to secure the right to make health-care and life decisions for each other and for children.
In the unlikely event that you are thinking of splitting up just to dodge the marriage penalty, be careful. After some couples in the 1970s obtained quickie Caribbean divorces at year-end and then remarried early the next year in order to lower their taxes, the Internal Revenue Service cracked down and disallowed such moves as "sham transactions." IRS Publication 17 has a stern warning against them.
Timing a wedding is fine, however. The law considers a couple married for the year if they are married as of Dec. 31, says David Lifson, a CPA at Crowe Horwath in New York who advises many couples composed of two high-earners.
"I've had three clients throw a New Year's Eve party and get married just after the stroke of midnight," he says. "The one-year savings more than paid for the party."
Just ask Chris Lacerenza and Cara Godsey, who were married in March in Cincinnati. Mr. Lacerenza, a 31-year-old accountant and wealth adviser, and his wife, 30, who sells medical screenings, figure they will owe at least $2,100 in extra federal taxes this year simply because they got married—and that figure likely will rise as they earn more and have children.
Two-earner couples with higher incomes could easily owe a five-figure marriage penalty.
To be sure, not all couples wind up owing more. The current tax system can even produce a marriage bonus if one spouse provides most or all of the income.
For example, a married couple with two teenagers and $150,000 of income, all provided by one partner, would owe nearly $4,600 less than what they would as singles, according to the nonpartisan Tax Policy Center in Washington. In addition, at-home spouses can often contribute to an individual retirement account or Roth IRA.
But a marriage tax bonus can quickly disappear. If just $25,000 of this couple's total $150,000 income is instead earned by the second spouse, says economist Roberton Williams of the Tax Policy Center, the bonus could become a penalty of about $2,000.
There aren't any current data on the size or number of U.S. taxpayers' marriage penalties or bonuses. But according to a U.S. Bureau of Labor Statistics report published this year, the contribution of wives' earnings to overall family income rose to 38% in 2010, up from 27% in 1980. As spousal earnings converge, the likelihood and size of marriage penalties rise.
For example, if the hypothetical spouses cited above each earn $75,000, rather than one partner earning $150,000, they could incur nearly $4,000 more in tax compared with what they would owe as single filers with the same income, deductions and children.
"That's an annual hit," says Randall Smith, a CPA at Samet & Co. in Chestnut Hill, Mass. "None of my clients has ever backed out of a marriage because of the penalty, but people are often surprised by how high it is."
Why do marriage bonuses and penalties exist? "Society has changed, but the tax system is still designed for a world in which one partner works and the other stays home," Mr. Williams says.
Not Keeping Pace
The U.S. income tax is progressive, with higher rates on higher income. But the tax brackets for married couples aren't twice the ones for singles—except for the two lowest rates of 10% and 15%. For example, this year's 35% rate kicks in at the same income for both single and joint filers: $398,350. For the top rates of 39.6% for income tax and 20% for capital gains, the threshold is $400,000 for singles but only $450,000 for joint filers (see chart on this page).Filing a joint tax return means that the second income "stacks" on top of the first, and a married couple can quickly owe more than two singles with the same combined income.
A host of provisions, such as credits and deductions, also phase out for people at higher incomes and help trigger a higher tax bill for two-earner married couples. For example, taxpayer contributions to Roth IRAs are usually curbed beginning at $112,000 for singles but at $178,000 for married couples.
Experts say the largest marriage penalty as a share of income affects low earners who are married with children. Still, the penalty on high-earning couples with two incomes has grown this year. In January lawmakers raised tax rates on ordinary income and capital gains and passed limits on personal exemptions and itemized deductions. There also is a new 3.8% surtax on net investment income, plus a 0.9% increase in payroll tax.
All these increases affect higher-income taxpayers, and in each the threshold for singles is far more generous than the one for married couples. For example, a couple with two teenagers and $500,000 of total earnings, split equally between the two partners, would see their marriage penalty rise from about $15,000 last year to more than $17,000 for 2013, according to the Tax Policy Center.
In general, two-earner couples who make less than $200,000 a year will incur smaller penalties because they aren't subject to the new rates and phase-outs, experts say. More of their income also falls into the first two tax brackets, where the marriage penalty has been eliminated.
'A Steep Price'
Given the tax code's many quirks, however, marriage penalties can hit middle-income earners as well. The newlywed Lacerenzas, for example, aren't subject to some of this year's tax increases. But they will owe that $2,100-plus marriage penalty this year in part because Ms. Lacerenza wrote off her mortgage interest last year, while her then-fiancé instead took the standard deduction, which he can't take this year."It's a steep price to pay," Mr. Lacerenza says, "but worth every penny, to be married to my best friend."
Because of the tax code's complexity, the marriage penalty or bonus for individual couples will vary widely, especially if they have children. To find out where you stand, check out the calculator posted at taxpolicycenter.org/mpc.
The current provisions are deeply rooted in the tax code and lawmakers would find them expensive to alter, so marriage penalties for two-earner couples will probably last longer than many marriages. Here are strategies that can help lower the bill.
• Reduce reported income.
The marriage penalty can increase with income, especially if a two-earner couple has children and income above $250,000. That means families should make use of strategies that reduce their adjusted gross income, or AGI, which is found at the bottom of the front page of the 1040 form.
Among the items that help on this score are deductible contributions to tax-favored retirement plans, such as 401(k)s, IRAs and pensions, and pretax dollars used to pay for health coverage, a health savings account or a flexible spending account for either health or child-care costs.
Capital losses that are "harvested" can be used to offset future gains, also reducing AGI. Charitable gifts made with assets that have risen in value, which are allowed within certain limits, also can be beneficial when compared with cash gifts.
Although contributions to 529 college-savings plans and Roth IRAs aren't tax-deductible, the income earned on these accounts can be tax-free. Tax-exempt municipal-bond interest doesn't raise AGI, either, although it does count in calculating taxes on Social Security benefits.
However, itemized deductions such as those for mortgage interest, charitable donations, state income and property taxes, and other items from Schedule A, don't help lower your AGI.
• Time income windfalls where possible.
Do you expect a windfall, such as from the sale of a long-held asset? Careful planning—perhaps with expert help—could reduce a marriage penalty and other taxes.
For example, a couple planning to sell appreciated stock to pay tuition might benefit by selling part in December and part in January to lower their reported income.
There is some good news for homeowners: Experts say that in all but a few high-priced real-estate markets, couples selling houses won't see higher taxable income from the sale. The first $500,000 of gain on the sale of a principal residence is tax-free, and the purchase price plus any capital improvements are excluded from the gain.
So if a couple bought a house for $300,000 and did a renovation costing $150,000, then they could sell the house for as much as $950,000 without raising their taxes.
• Consider an IRA charitable rollover.
IRA owners who are 70½ or older should consider using this highly popular technique for donations totaling up to $100,000 a year. It allows the taxpayer to transfer assets directly from the account to a qualified charity such as a church, school or other group. Such donations can count as part of an IRA owner's required annual withdrawal.
Although there isn't any tax deduction, you needn't report any income. If a donation were made in the conventional way—by reporting income and then deducting a donation—adjusted gross income would be higher. By reducing such income, rollovers can help reduce the marriage penalty, as well as income-based Medicare premiums and taxes on Social Security payments.
This tax technique has had a rough ride in recent years, as Congress has let it lapse and then reinstated it only at the last minute. The current version is in effect through the end of 2013.
• Consider filing separately.
Married couples are often surprised to find that they simply can't file as two single people. There is a "married, filing separately" category, but it is set up so that in most cases couples who choose it pay more. "Its main benefit is to sever the legal liability of spouses for a joint return," says David Kautter, a CPA at the Kogod Tax Center at American University.
There are a few exceptions, however. If one spouse has large tax-deductible medical expenses, say from a nursing home, there could be a benefit to filing separately, Mr. Kautter says. More rarely, it could make sense if there is a large casualty loss, such as for a vacation home destroyed by a storm, or a large miscellaneous deduction such as for unreimbursed employee expenses, and the loss or expense is attributable to one spouse.
• Don't get married.
It is a radical move, but some couples choose to opt out.
"Marriage is not the only legitimate outcome for a committed relationship, even one with children," says Cindy Butler, a spokeswoman for the group Unmarried Equality, a Seattle nonprofit that promotes equal financial and legal treatment of single and married people.
She and others caution that couples who choose not to wed should complete legal paperwork to secure the right to make health-care and life decisions for each other and for children.
In the unlikely event that you are thinking of splitting up just to dodge the marriage penalty, be careful. After some couples in the 1970s obtained quickie Caribbean divorces at year-end and then remarried early the next year in order to lower their taxes, the Internal Revenue Service cracked down and disallowed such moves as "sham transactions." IRS Publication 17 has a stern warning against them.
Timing a wedding is fine, however. The law considers a couple married for the year if they are married as of Dec. 31, says David Lifson, a CPA at Crowe Horwath in New York who advises many couples composed of two high-earners.
"I've had three clients throw a New Year's Eve party and get married just after the stroke of midnight," he says. "The one-year savings more than paid for the party."