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2010 CCH Whole Ball of Tax
Single or Married? It Makes a Big Difference at Tax Time
(RIVERWOODS, ILL., January 2010) – The answer to the question posed at the head of every income tax return – single or married? – can substantially affect your tax bill, according to CCH, a Wolters Kluwer business and a leading provider of tax, accounting and audit information, software and services (CCHGroup.com).
“In terms of both penalties and rewards, people who are married, single or living together as domestic partners are treated differently under the tax law,” noted CCH Principal Federal Tax Analyst Mark Luscombe, JD, LLM, CPA. “What’s more, it isn’t always clear what the tax effects of different marital decisions will be.”
The tax law touches on so many different aspects of life that it’s not always possible to anticipate all of the effects marriage might have on your taxes over a lifetime. According to Luscombe, more than 60 provisions of the Internal Revenue Code specifically apply to married couples and can either help or harm these taxpayers.
A Lessened “Marriage Penalty”
The “marriage penalty” is one of the better known, and most enduring, tax consequences of being married. Despite attempts in Congress to eliminate the penalty starting with legislation passed in 2000, it persists in a lessened form today.
At one time, there were two obvious sources of the marriage penalty. First, the standard deduction allowed on a joint return was less than twice the amount of the standard deduction for single filers. Second, a couple could move into a higher tax bracket when their incomes were combined on their joint return. Add together two incomes that each might be taxed at 15 percent and you could get a joint income taxed at 28 percent.
Over the past several years, though, the standard deduction for joint filers has been raised to double that of singles, and the 10- and 15-percent tax brackets are now twice as high for joint filers, as well. But beyond the 15-percent bracket, the classic “marriage penalty” lingers on.
The Marriage Penalty at Work
Suppose that Holly and Peter each have a taxable income of $75,000, toward the top of the 25-percent bracket for single filers. As domestic partners who file singly, each pays income tax of $14,544 after the “Making Work Pay” credit. If they tied the knot and the tax laws were marriage-neutral, their tax would be twice that amount, or $29,088. But that’s not how things work.
Filing jointly, Holly and Peter report taxable income of $150,000. The 25-percent tax bracket for joint filers ends at $137,050, so the top $12,950 of their joint income is taxed at 28 percent, leading to a total tax bill of $29,463.50 – a “marriage penalty” of $375.50.
Distribution Determines Penalty…or Bonus
It’s important to note, however, that it’s the distribution of income – 50/50 between the two spouses – that produces the penalty. If Holly were a single professional with a taxable income of $150,000, she would not be eligible for the Making Work Pay credit and would owe $35,720. So she would reduce her income tax and reap a “marriage bonus” of $6,256.50 if she were to marry a charming but penniless drifter.
“When the income tax first came into being, the typical family included only one wage-earner,” Luscombe said. “As a result, some people, especially those in ‘traditional’ families with a principal wage-earner, benefit from the same structures in the tax code that penalize others, such as those in dual-income situations.”
Invest in the Right Marriage Partner
One difficulty in figuring out whether marriage is attractive from a tax point of view is that different types of income can be taxed differently. If a couple has capital gains and losses, the picture is mixed. A married couple can deduct only $3,000 in capital losses on a joint return, the same amount each could claim filing singly. This looks like a marriage penalty. But on the other hand, one partner can offset gains in the stock market with the other’s losses, a provision that can lead to enormous savings.
Consider Kathy and Neal, each with taxable income from wages of $75,000. Suppose that Kathy has $25,000 of long-term gains in the stock market and $1,000 in losses, while Neal has nothing but $20,000 in losses.
Filing singly, Kathy would have $24,000 in net gains, which are taxable at 15 percent, or $3,600 in capital gains tax and a total tax bill of $18,554. Neal could offset his other income with $3,000 of losses, and since he’s in the 25-percent bracket that amounts to a reduction in tax of $750, making his total tax $13,794. The rest of his losses must be “carried forward” to be applied against his gains, if any, in futureyears.
As a married couple, however, Kathy’s and Neal’s capital gains and losses can be offset, so they would have a net gain of only $4,000 and a capital gains tax of $600. Their total tax bill as a couple would be $30,143.50, whereas their individual tax bills would have totaled $32,348. This is just one example of how a marriage penalty can be turned into a marriage bonus – if you pick a partner with the right portfolio.
Earned Income Credit Can Be Marriage Disincentive
There is a special and ironic marriage penalty that can hit hard at the low end of the income scale. Two unmarried wage-earners who each have children and are just making it with the help of the earned income tax credit (EITC) – a refundable credit and a tax vehicle to encourage work over welfare – often face a tax disincentive to tying the knot.
Suppose, for example, that Kim and Doug living apart, each earn $25,000, each have one child and can file as head of household, which will entitle each to an $8,350 standard deduction for 2009 taxes. Unmarried, each is entitled to a 2009 EITC of $1,668. Combined with the $1,000 child credit each is entitled to, this eliminates their federal income tax obligations and even produces a payment to each one from the Treasury of nearly $2,000. If they had filled out the proper employment tax forms, they could have received that refundable credit throughout the year in their paychecks.
But suppose that these two low-wage workers decide to get married. What sort of wedding present do they get from Uncle Sam? Kim and Doug get a slightly higher standard deduction as joint filers rather than heads of households, but at $11,400, it’s nowhere near double the amount that they were each entitled to as single parents. Worse, with $50,000 in wages, the couple no longer qualifies for the EITC.
The bottom line is that the couple receives a refundable credit of only $31, and without this year’s Making Work Pay credit would owe several hundred dollars in taxes, losing out as a result of marrying.
Penalties, Bonuses Abound in Tax Law
The discrepancies in tax brackets and the EITC are commonly cited provisions that can produce marriage penalties. But even if they were magically mended, dozens of tax law provisions would remain that can produce pluses or minuses for couples as opposed to singles.
The credit for the elderly, the general business credit, the alternative minimum tax, the taxation of Social Security benefits and the phaseout of personal exemptions – all can produce either a penalty or a bonus, depending on whether the incomes of the two spouses are relatively equal or unequal.
Other provisions are much more likely to produce a bonus, with little likelihood of a penalty, for married taxpayers. For example, Holly and Peter each can exclude $250,000 in gain on the sale of a personal residence as singles. As a married couple, they can exclude up to $500,000 in gain, even if the house is in only one of their names.
How the Code Favors Marriage
The tax code also can work to favor marriage in ways that may not jump from the pages of the Form 1040 and its various schedules. For example, a spouse is automatically a “dependent” in the eyes of the law, even in a marriage in which husband and wife have identical incomes. Under federal law, this makes group health coverage for the spouse a tax-free benefit when an employer provides it. And when a spouse’s $50,000 hospital bill is paid by an insurance plan, that too is tax-free.
By contrast, it’s more difficult for an adult partner to qualify as a dependent in the eyes of the IRS, so even when unmarried couples are granted “domestic partner” benefits by companies, the benefits they are given are diminished through taxes. Since the signing of the federal Defense of Marriage Act in 1996, marriages between people of the same sex, where they are allowed by state law, have no effect for federal tax purposes.
For example, a group health policy for a domestic partner or same-sex spouse that is subsidized by an employer to the tune of $4,000 a year is treated as an additional $4,000 of taxable income for the employee.
“Most people would say that it’s better to have to pay federal income tax on the extra $4,000 than not to have the coverage,” Luscombe noted. “Still, this is a tax hit that would never apply to a traditional married couple with employer-provided health insurance.”
Traditional spouses also are favored when it comes to pensions and inheritances, Luscombe observed.
“The surviving spouse in a two-sex marriage can inherit a husband’s or wife’s estate without any federal estate tax. That’s not the case for any other relationship,” Luscombe said.
A Few Federal Tax Breaks for Non-spouses
In 2006, Congress passed two measures that give non-spouses better breaks in one small area of the tax code. First of all, as of 2007, non-spouse beneficiaries can roll over assets they receive from the deceased owner of a qualified plan into a special “inherited” IRA, avoiding tax on the money until it is actually taken out, either over their lifetimes or over five years. Without this provision, non-spouse beneficiaries were often required to receive all of the distribution in a lump sum and pay taxes on the entire amount.
Spouses still fare better, though. They can “step into the shoes” of the deceased owner of the plan by rolling the assets over into their own IRA, which they do not have to tap until they reach age 70½.
Non-spouse beneficiaries also have the same footing as spouses and other dependents when it comes to determining whether a “hardship” exists that would allow a plan participant to take a hardship withdrawal of retirement savings.
“Despite these recent moves, it’s clear that Congress has not been scrupulously marriage-neutral in crafting tax laws, nor is a truly neutral tax code something we are likely to see anytime soon,” Luscombe said.
Same-sex Marrieds Have to Figure Taxes Twice
Although federal law does not recognize marriages or civil unions between same-sex couples, several states do. Those couples then have to figure their taxes twice, using different statuses for their federal and state filings.
For their federal return, each individual must use the “single” or possibly “head of household” status. On their state return, the couple can file jointly or as “married filing separately.” As a practical matter, this usually means computing a second federal return that won’t be filed but with the correct state filing status, then transferring amounts from that second return to the state return.
“From a tax point of view, marriage has always been a little more complicated than it looks,” Luscombe said. “This latest wrinkle just confirms that.”
About CCH, a Wolters Kluwer business
CCH, a Wolters Kluwer business (CCHGroup.com) is a leading provider of tax, accounting and audit information, software and services. It has served tax, accounting and business professionals since 1913. CCH is based in Riverwoods, Ill. Wolters Kluwer is a leading global information services and publishing company. Wolters Kluwer is headquartered in Alphen aan den Rijn, the Netherlands (www.wolterskluwer.com).
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