Tax on Marriage

The following is provided courtesy of Marotta Asset Management and provided their thoughts on taxes on marriage:

Few Americans look forward to the idea of filing taxes. At best we feel like Dorothy being dropped into the Land of Oz. At worst, we feel like the Wicked Witch of the East having the house dropped on us.

As Glinda advises us, "It's always best to start at the beginning," and at the beginning of the tax return is determining your filing status. You would think that this is an easy and straight forward question. But since this is the beginning of dangerous journey on the yellow brick road, it is worth understanding the inequities that this section of the code causes.

Two different people with the exact same income and the exact same deductions can end up with very different amounts of tax owed, simply because of their filing status. Married couples -rich and poor alike- often bear the brunt of the inequities created by our current tax system

Every tax system does a certain amount of harm. The more progressive the tax system, the more devastating the unintended consequences. No marriage-neutral tax system can exist given a progressive taxation system.

Most people wrongly assume that the marriage tax penalty was eliminated by some of the tax changes that were enacted and gradually implemented over the past several years. The marriage tax penalty was eliminated in the 10% and 15% brackets by increasing the number of married couples who get special tax breaks.

Let's look at some examples.

Michael and James work in the same business. Each makes the same salary and takes the same deductions. The only difference is that Michael's wife stays home, while James's wife works at the firm.

In this case, the tax code gives Michael and his wife a tax break. Michael gets the benefit of claiming two personal exemptions (one for himself and one for his wife). The tax code favors these provider/dependent marriages like Michael's. They are better off filing jointly since Michael's wife - who is not earning any income - can't put her personal exemption to good use. But by filing jointly, Michael and his wife can use both personal exemptions, thus lowering the taxes on Michael's earnings.

However, James and his wife find themselves paying significantly more tax simply because they are married filing jointly.

If James and his wife are both low-income their filing status will dramatically change their tax status. A low income couple who marries and combines their income can forfeit other programs designed to help the truly needed. The most important of these programs is the Earned Income Tax Credit (EITC).

For 2007, a couple's income must be under $39,783 in order to qualify for EITC, while filing single or head of household must be under $37,783. Imagine a couple where each makes about $20,000 a year and you can see their dilemma.

EITC isn't small change either. In fact it is a much better way of targeting poor working families than raises to the minimum wage. For 2007, the maximum EITC credit is $4,716 which can make a huge difference in a struggling family.

The marriage penalty remains even if James and his wife are well-off. They are taxed as though they represent one very high income taxpayer and must pay more than they would if they were unmarried and just living together.

Most likely, neither Michael nor James will let the tax code determine if they should get married. But you can bet that Michael's wife and James's wife will let the tax code determine how much they are willing to work.

Because James and his wife are taxed at a combined rate, there is very little incentive for James's wife to continue working. Another way to think of it is a tax on families with two earners. In other words, it is a tax on married women whose husband's work, especially on women with high incomes.

James and his wife, by combining their incomes, have pushed each other into the top marginal tax bracket. That means for every dollar that James's wife earns, she is probably taxed at over 50%, including federal, state, and local taxes.

Now compare James's situation with Michael's. If Michael's wife can save a dollar by bargain shopping and preparing homemade meals, they are a dollar richer. James and his wife would have to earn at least two times as much to fare as well. Because of their combined income pushing them into the highest tax brackets, the government will take over half of everything they earn.

They will also have additional expenses as a result of working, and few, if any, of these expenses will reduce their income. Their business clothes, gas, and child care expenses may all have to get paid with after tax dollars making these expenses two times more costly than the income they may generate.

If all of this public policy debate makes your head swim, you are not alone. The bottom line is: The flatter the tax system, the less it matters whether couples combine their incomes or not. If every dollar of income were taxed the same and there were no deductions or credits, it would not matter if James and his wife combined their incomes. The same flat percentage of a combined amount is still the same flat percentage.

Practically speaking, many couples would be better off having either mom or dad stay at home. Having one family member who is working at reducing expenses and improving lifestyle can be the least expensive way to increase family wealth. Saving money by doing more things for yourself is worth two times the income earned by the spouse who winds up in the top brackets. And besides, "There's no place like home."

Comments

[plonkee]

Staying at home is a decision with serious implications for the rest of your life. You may never get back onto the career ladder at the same level etc, etc. I wouldn't suggest that someone give up their career just because of the tax, it has to be something you do for its own sake.

I have to admit that I find the US tax system odd. Over here, everyone is essentially taxed as an individual.

[beastlike]

Well said, which once again proves that our current tax system is crap!

[Minimum Wage]

For 2007, a couple's income must be under $39,783 in order to qualify for EITC, while filing single or head of household must be under $37,783.
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Um, not exactly. A single (i.e. childless) filer must have 2006 income under $12,120 or a 2007 income under $12,590 to qualify for EITC. Since a full-time minimum wage earner would earn close to these amounts, they would qualify for a very small EITC, considerably less tghan $100.

[Minimum Wage]

I have long been fascinated by this stuff (I shoulda been a CPA). I find it interesting that many religious conservatives laud the stay-at-home mom, while decrying the marriage penalty which encourages moms to stay at home. I similarly find it interesting than many secular conservatives have had no difficulty with the marriage penalty on low-income families. The latter is reminiscent of Reagan's early (1981) move to reduce welfare benefits one dollar for every dollar of reported earnings. Reagan's rationale? We don't have money to subsidize the working poor.

[Mrs. Micah]

*sigh*

Fortunately, my husband's extra income this year won't up us in the tax brackets. He's only made about $7000 total as a student teacher. But in the future this may be a real pain!

[Mary]

WOW!! Talk about a sexist article. We should be fighting to truly eliminate the marriage penalty not make a decision on whether both spouses should work based on the tax code!!!

[Minimum Wage]

I'm working on a proposal for that. I already have an Alternative Maximum Tax.

[Susy]

My tax guy figures out our taxes both ways and then files whichever way is most financially beneficial for us . Gotta love it, depends on the year on how we file.

[Minimum Wage]

Your state might also have obscure tax rules which can be exploited to save money. While tax prep software is nice, a good human professional is more likely to be on top of recent changes, esp at the state level.

I once saved a former employer a nice chunk of cash - in Michigan, homeowners can use the property taxes BILLED to qualify for a "circuit breaker" rebate even if the property taxes remain unpaid at the end of the year. My employer had a biennial income cycle, so using my tip, he would let the prop taxes slide in his "off" year while still using the taxes billed to get a hefty rebate. He would catch up the property taxes the next year when he netted six figures and wouldn't qualify for the rebate anyway.

[Russ]

You can say this gives you an incentive to stay home....or an incentive to put much more money away in a 401k.

[Kevin]

While there is still is a "marriage penalty" in the tax code, this column does a pretty crappy job of explaining it. I'm not a big fan of scare tactics, which it seems to make good use of. And they conveniently leave out the fact that the working spouse (James' wife) also gets to use a personal exemption.

Not to mention the fact that the tax rate schedules have been cleaned up so that the single brackets are now exactly half of the married, filing joint brackets for the 2 lowest rates (which I would guess is a pretty high percentage of taxpayers).

It's clear they favor a flat tax, and they are entitled to their opinion. However, a flat tax will still have loopholes that will be exploited.

[Curtis]

I agree with Kevin. Not much research seemed to really go into this, more of just scare tactics. Flat taxes aren't all that great either. I just did the analysis on the flat tax myself and posted on my blog yesterday. It's not all it's cracked up to be!

[Rick]

What Kevin said is decidedly untrue. If you look at the IRS web site (http://www.irs.gov/formspubs/article/0,,id=164272,00.html), the tax brackets for singles are indeed half the brackets for married filing jointly in the lower brackets, but in the remaining tax brackets there is a very obvious marriage penalty. For instance, using the 2007 tax brackets, if both the man and the woman each make 100K of taxable income, if they are both single, each will pay $22,110.75 of tax, for a total of $44,221.50. However, if they are married and file jointly, their combined tax will be $45,200, or about $1000 more. This is because when filing jointly they are pushed into the 33% tax bracket, whereas by filing as a single, they are still in the 28% bracket.

[Rick]

Never mind, Kevin mentioned the tax brackets are only half of the married brackets in the lowest 2 rates, which is correct. The marriage penalty has been largely eliminated for lower income couples, but not for more wealthy couples.

[Minimum Wage]

Actually, the remaining marriage penalty kicks in for couples in all brackets if their combined income puts them in a higher bracket than at least one of the individuals would pay if single.

For example, a large proportion of married couples who are individually in the 10% bracket will wind up in the 15% bracket when they file jointly. The same can happen to marrieds in the 15% bracket who jointly wind up in the 28% bracket, etc.

[Income Tax]

Tax on Marriage?
Tax here
Tax there
Taxes everywhere
I will pay taxes till the day I die, married, born...
Arghhhhh

Christine

[Lord]

Marriage penalty? It is most often a marriage benefit because for most couples one earns much more than the other and combining incomes allows them to average to a lower level than the two of them would pay separately.

How about an example of a couple in the top 5% of US incomes:

You and your spouse each make $200,000 a year, each making $100,000. You have an additional $1318 tax burden. That's about 0.6% of income.

It's hardly going to keep someone out of the workforce.

The marriage tax is less for lower incomes, and goes to 0 at $60,000. And like Lord says, there's usually a marriage gift, since incomes are generally unequal. And we haven't mentioned that a higher income married couple probably has a bigger mortgage, which means more of a tax writeoff for mortgage interest. They're also in a better position to take IRA and 401k tax deductions.

[GLM]

We did the math 22 years ago with 2 kids - newborn & age 3. We found I would be working full time to come out $50/month ahead after childcare and second car. I decided to stay home, clip coupons, sew more and drop the second car- walking to store & library with the kids.

Next 5 years were really tight. But - 1)Kids learned to read before school 2)spouse's carrier did better as he could concentrate on breadwinner role & we moved easier to further carrier progress. 3) I got really good at money management (and sewing ) 4) and a better cook 5) probably a LOT more I can't think of right now .

That said -it is not something I would recomend for anyone who's marrage is in anyway shakey.

Now shooting for early retirement. Childern are self supporting engineers - no debt (well new grad - Chem Eng has about 3K left on her car note - establishing credit)

I think about going back to work but paying the taxes I would incur as a second income in a high income family is a disincentive! Besides with the kids gone now I can finally travel with my husband on business- not easily done when raising children.

I worry about how this skewed thing in the tax code will impact our children. It does not encourage highly educated couples with strong earning potental to pursue two carriers.It is a success tax .

BTW - I still clip coupons.

[Minimum Wage]

Actually, higher-income couples are often in a WORSE position to take tax deductions because many deductions are phased out starting around $100K or so - not to mention the AMT getting in the way of deductions.