A wedding is a solemn event that marks a personal commitment. So it's no surprise that taxes are probably the last thing on your clients' minds when they are on the threshold of marriage. But when choosing a date for the wedding, it pays to consider what time of year the nuptials will take place. Choose December, for example, and the IRS may turn out to be an unexpected guest.
Couples should be made aware that saying "I do" before or after the stroke of midnight on New Year's Eve can make a significant difference in the size of their tax bill for two full years. The rule--too often overlooked--is that their marital status as of Dec. 31 usually determines their filing status for the entire year. In other words, the IRS ordains that you are a married person for all of 2008 even if you should get hitched as late as Dec. 31. (By the same token, even though in anticipation of divorce, spouses may be living apart, absent the final decree the IRS considers them to be married for all of 2008.)
Why does a walk down the aisle in December lead the newlyweds into a tax trap? Assuming--as is increasingly common--that their earnings are relatively equal, the taxes that the two of them are required to pay on their combined incomes as Mr. and Mrs. can be considerably higher than they would be for singles who share bed and board and report exactly the same incomes. While the 2003 tax act gave partial, temporary relief to most couples, this much criticized Internal Revenue Code quirk has come to be known as the "marriage penalty" (or, depending on one's point of view, the "sin subsidy").
Moreover, the act did not end the penalty for all couples. For 2002 and earlier years, the snag was the long-standing problem of bracket creep--that is, higher income means a higher tax rate. In tax year 2002, for example, for singles, the bottom bracket of 10 percent applied to taxable income of up to $6,000; the 15 percent bracket applied to taxable income between $6,000 and $27,950. So as singles, individuals might have most of their separate incomes taxed at a top rate of 15 percent. The next higher rate for singles of 27 percent kicked in only after taxable income surpassed $27,950.
Marriage, however, required those same individuals to combine their incomes. Consequently, the top rate for the first dollar of the second income was the same as the rate for the last dollar of the first. Result: A larger slice of their income was taxed at the next higher rate for joint filers--also 27 percent. And the higher rate applied as soon as taxable income surpassed $46,700.
President Bush's 2003 tax package provided millions of two-income couples with partial, temporary relief from the marriage penalty. One change placates most joint filers by increasing their standard deduction--a flat amount based mostly on filing status and age--to twice the standard deduction for single filers (for 2008, $10,900 for joint filers and $5,450 for single filers). Consequently, two non-itemizers who decide to wed no longer suffer the loss of some of their standard deductions. But after 2010, this provision "sunsets," and unless Congress acts to extend it, the standard deductions revert to the amounts they were before the 2001 tax act took effect.
A second helpful change for joint filers authorizes a larger slice of their income to be taxed at the 15 percent bracket, rather than the next bracket of 25 percent. After 2010, this provision also expires, unless Congress decides differently.
Despite changes in the law to alleviate the marriage penalty, situations still exist where dual-income couples will lose more to taxes than they would as singles. True, the marriage penalty need not concern couples who each have taxable income under the top end of the 15 percent bracket for singles--$32,550 for 2008. Married or unmarried, they remain within the 15 percent bracket.
But suppose each spouse has taxable income for 2008 of $75,000. As single taxpayers, each person stays well below the top end of the 25 percent bracket ($78,850), whereas if they marry and file jointly, more than $18,000 of their combined income of $150,000 would spill over into the 28 percent bracket (taxable income between $131,450 and $200,300).
Or suppose each party's taxable income for 2008 is $110,000. As single filers, each is in the 28 percent bracket; as joint filers, they move up to the 33 percent bracket. The marriage penalty ceases to kick in only when each is in the top bracket of 35 percent--that is, taxable income of more than $357,700, whether single or joint.
Critics were quick to point out that the 2003 tax act trims taxes for married individuals who already benefit from a tax "bonus" if one spouse earns the entire income or considerably more than the other spouse. Moreover, increasing the standard deduction does zip for couples who itemize deductions--such as charitable contributions and real estate taxes-- as do most higher income households. Still, the increased standard deduction means fewer couples will need to itemize on Schedule A of Form 1040.
The marriage penalty, says Michael Graetz, a Yale law professor and former Treasury Depart-ment official, is "one of the major reasons the American people have become so dissatisfied with the income tax. When a tax system departs dramatically from the fundamental values of the people it taxes, it cannot sustain public support." But take heart. Tax-savvy couples can easily sidestep the marriage penalty for 2008; all they need to do is postpone the nuptials to 2009.
Reversing direction, are there couples who save on taxes by marrying in December? Absolutely. The right set of numbers transforms the penalty into a bonus. A December marriage can be a smart move when one spouse earns all the income or a good deal more than the other, as explained above. Their taxes as a couple filing jointly will be less than if they were unmarried.
Another example: Suppose one of the engaged parties has a capital loss carryover from a previous year, and the other person has capital gains. Then it might be advisable to wed this year and use the carryover to offset the gains.
Similar rules apply to couples who decide to sever their ties. A divorce near the end of the year means that the estranged spouses forfeit all the benefits of joint filing for all of 2008. Only couples who are able to grin and bear it through Dec. 31 can save taxes. What if being single provides an advantage? Then they can achieve that goal only if they undo their marriage by Dec. 31.
These tax quirks have not gone unnoticed by tax savvy, dual-income couples. To the surprise of no one but the IRS, an increasing number of these couples have journeyed to Haiti or some other equally obliging place to get a divorce in December and then to re-marry in January.
On "60 Minutes" and other national television programs, some affluent couples revealed that they slip into and out of marriage with annual quickie divorces just so they can file as two unmarried persons and save a sizable sum in taxes. These year-end arrangements prompted a public relations conscious IRS to issue a prim warning: Revenue Ruling 76-253 specifies that the IRS will disregard a divorce obtained solely to save taxes and will require the couple to recalculate their taxes as if they had stayed married for the entire year. That means they become liable for additional taxes plus interest and possible penalties.
A beleaguered IRS readily concedes that there is nothing to stop couples from filing as single persons as long as they get a regular divorce and simply live together out of wedlock. This arrangement has become a socially acceptable way of life for the more than five million couples who fit the Census Bureau descrip-tion of POSSLQs--Persons of the Opposite Sex Sharing Living Quarters.
To stop another end run around the marriage penalty, those IRS spoil-sports issued Letter Ruling 7719014. This ruling states that a pact entered into before a couple married did not entitle the two-income couple to file as unmarried persons. It seems that the couple who sought the ruling agreed to function toward each other as "fully independent, single individuals with none of the financial characteristics which are usually present in a marriage relationship." But this eminently practical arrangement got them exactly nowhere with an unsympathetic IRS, which decreed that a couple who enter into a valid marriage cannot escape the marriage tax merely by making a private agreement.
Some couples contend that our tax system is unconstitutional because it forces many working married persons to pay more taxes than they would if they stayed single. But the courts have ruled otherwise. All the system does is "change the relative attraction of different prospective spouses," concluded a United States Court of Claims Judge in a 1978 case. "For the tax-minded young man or woman with a substantial income," the ruling continued, "the Internal Revenue Code adds to the attractiveness of a prospective spouse without taxable income and detracts from one with it." Taking note of the changes in our moral attitudes, the judge also observed that two-paycheck couples who cohabit without sanction of clergy "can enjoy the blessings of love while mini-mizing their forced contribution to the federal coffers."
The single versus married tax arguments have seesawed over the years. For example, in 1981 Congress wanted to muffle complaints that it sided with promiscuity and opposed the sacred institution of marriage. That was the year Congress authorized a deduction designed to provide partial--not complete--relief from the federal marriage indenture for two-paycheck couples. The revised rules entitled working married persons filing jointly to deduct 10 percent of the first $30,000 in earnings of the lower-paid spouse's income for a maximum deduction of $3,000. Despite the deduction, many two-earner couples continued to feel that they were unfairly penalized by our tax system. Worse yet, marriage penalty relief resulted in new "inequities." The full deduction became available only when each spouse earned a minimum of $30,000. No deduction was available when one spouse was unemployed, even though he or she may have had substantial investment income from other source s such as stocks or rental property.
Will a changing of the guard in November bring still more changes in the marriage penalty? We'll just have to wait and see.
Julian Block, an attorney and syndicated columnist based in Larchmont, N.Y., conducts continuing education courses for financial planners and other professionals. Information about his books is at julianblocktaxexpert.com.