Can you say "I do" to your sweetie and not say "I do" to more tax?
Today’s topic is marriage and taxes
A listener named Jason sent me this question:
This upcoming year I’m getting married! I always used to joke with my fiancé that we'd never get married because of the “tax penalty.” Although I was joking, there seems to be some truth to this. She’s currently a low-income earner with no significant deductions (aside from an IRA), and therefore she takes the standard deduction on her tax return. Meanwhile, I’m a high-income earner with many deductions and therefore itemize on my tax return. When we get married this year, will her non-itemized return severely hurt my itemized return when we file jointly? What about filing married but separately? Will that help? If not, is there anything we can do to protect ourselves?
First off, congratulations on your upcoming marriage, Jason! You’re smart to be thinking about the tax implications for you and your wife-to-be, because matrimony can change your tax bill for better or for worse!
No Romance in the Tax Tables
The marriage penalty is, unfortunately, one of the more unromantic parts of the Federal tax rate schedules. The marriage penalty arose in 1969 when Congress attempted to adjust for a tax advantage that existed for married couples compared with singles. As a result, some – but by no means all – married couples pay more tax than they would if they were single.
But tax laws in more recent years have actually eliminated the marriage penalty for tax payers in lower tax brackets. So here’s the good news: there’s no marriage penalty built into the tax rate schedules in the 10% and 15% tax brackets. For 2007 returns, the marriage penalty doesn’t kick in until a married couple’s taxable income is more than $128,500.
At a combined income just over this amount, a married couple would fall into the 28% tax bracket, whereas two singles earning $77,100 each (for a higher combined income) would still be in the 25% tax bracket. That’s the marriage penalty. In higher tax brackets, some married couples have to pay more tax than two single people earning the same combined income.
Couples with Disparate Incomes May Get a Bonus
But there can actually be a marriage bonus if a married couple has disparate incomes. Let’s take for example, two single people we’ll call Fred and Ginger. If Fred earned $30,000 and Ginger earned $70,000 in 2007, they would pay a total of slightly more than $18,000 in Federal income tax (based solely on the tax rates for 2007 and not factoring in deductions, other types of income, or anything else). If, however, Fred and Ginger married each other and filed jointly, they’d pay slightly less in tax: They’d pay $17,848 on their combined $100,000 income. So Fred and Ginger would get a little marriage bonus.
There’s No Marriage Penalty in the Lower Tax Brackets … for Now
The tax legislation that did away with the marriage penalty for lower brackets is in effect through the year 2010 and will need to be approved by Congress to continue in 2011.(1) If you pay less tax because of it and want it to continue, email your Congressperson to let them know! To make it easy, here's a link to find out how you can email your Congressperson.
Use the Deduction Method that Gives You the Biggest Break
OK, now let’s talk about deductions for a moment. How does marriage affect deductions? The standard deduction for a married couple is twice the amount for a single person, which is pretty fair and square. For 2007 returns, it’s $5,350 if you’re single and $10,700 if you’re married filing jointly.
Now, here’s a tip: Always use the deduction method that gives you the biggest tax break. If you reduce your tax bill by itemizing your deductions, itemize. If you save more in taxes with the standard deduction, take the standard deduction. If you have, say, $10,000 in deductions and your spouse has $5,000, you definitely want to itemize since your combined $15,000 in deductions is more than the $10,700 standard deduction for married couples for 2007 returns. But if you have, say, $7,000 in deductions and your spouse has $3,000, you won’t itemize since you’re better off taking the standard deduction.
Other Tax Penalties Married Couples May Face
Beyond the Federal tax brackets, there are other potential tax penalties a married couple may face.
For example, a single person who actively participates in renting out real estate can deduct up to $25,000 of losses against their earned income if their modified adjusted gross income is $100,000 or less, which is a terrific tax break. The deduction phases out for modified adjusted gross incomes between $100,000 and $150,000. It’s reduced 50 cents for each dollar your income exceeds $100,000. So if your modified adjusted gross income were $125,000, for example, you’d be eligible to deduct $12,500 in rental real estate losses from your earned income. If your income is $150,000 or more, you’re no longer eligible for the deduction. OK, so here’s where the marriage penalty enters the picture: This deduction is the same for a married couple as it is for a single person – meaning it doesn’t double like you think it would to be fair. So if Fred and Ginger were single real estate investors, they could each deduct up to $25,000 from their earned income for a total deduction of up to $50,
A second example of a potential tax penalty for married couples is the way excess capital losses are treated. A single person can deduct up to $3,000 in excess capital losses, but the amount doesn’t double to $6,000 for a married couple – it remains $3,000.
These are just two examples of marriage penalties above and beyond what’s built into the higher income tax brackets of the Federal tax tables.
Estimate What Marriage Means for Your Taxes
As you can see, there are different factors that affect whether you’ll actually pay more or less tax staying single or getting married! To understand the tax implications of getting married for your particular situation, your best bet is to estimate how much tax you and your spouse-to-be would pay filing single, married filing jointly, and married filing separately. To get you started, here's a link to the Federal tax rate schedule for 2008. You can also use software like TurboTax to see how changing your filing status would affect the amount of tax you and your sweetie would pay (or just refer to the Money Girl episode about filing status!).
As a general rule of thumb, married couples usually pay less tax filing jointly than separately. And, of course, you don’t have to do these estimates yourself if you don’t want to. You can hire a CPA to do them for you.
If you’re lucky, you may discover that you’ll get both wedded bliss and a tax bonus! And if you discover that you will pay a marriage penalty, be sure to let your sweetie know that there’s no doubt in your mind that he or she is worth it!
Keep in mind that both your financial picture and the tax code will change and evolve with time, so even if you and your spouse-to-be will pay more tax now married than you would if you were single, it may not necessarily be the case in the future.
Stressed Couple image courtesy of Shutterstock