Newlyweds and those contemplating marriage, congratulations! However, don’t forget tax planning in your nuptials. Be careful—your fellow married couples have been troubled by the so-called “marriage penalty” for years.
Congress has devoted significant time and attention in an attempt to eliminate the marriage penalty; however the various tax bills of the past 20 years have only provided limited relief. The 2017 legislation commonly known as the Tax Cuts and Jobs Act (TCJA) introduced the most sweeping changes to the individual income tax code in a generation. Did this legislation succeed where prior tax acts had failed? Unfortunately for married couples, the answer is likely no. In some situations, the marriage penalty is reduced or eliminated by the provisions enacted under the TCJA, while in others, the penalty remains or has even increased.
What Is the Marriage Penalty?
A marriage penalty exists when the tax on a couple's joint return is more than the combined taxes each spouse would pay if they were not married and if each filed his or her own return with filing status of single or head of household. The tax is more on a joint return when the couple's taxable income is pushed into a higher marginal tax bracket than would apply if the couple wasn't married (so they pay at a higher rate on the same total income than they would pay if each were single). This typically occurs with higher income couples, where both spouses work and have relatively equal incomes. The degree to which the marriage penalty applies to any given couple largely depends on the level of their combined income, the extent to which their individual incomes are similar and the number of children (dependents) they have.
In addition to the marriage penalty triggered by the tax rate structure, other code provisions penalize married taxpayers by linking deductions to income thresholds, or imposing limits on a “per return” basis. While these penalties do not apply to everyone, or in every year, they still increase tax when they do hit. Although penalties may seem small when evaluated annually, some of these penalties can remain in place for many years during the course of a marriage, greatly amplifying their impact.
What Triggers the Marriage Penalty?
The marriage penalty can arise in situations where the taxpayer’s income is used to determine eligibility for a deduction, credit or tax, and the thresholds for such deductions and credits for married filing joint taxpayers are proportionally related (not double) to those found for single taxpayers. Many situations can trigger the marriage penalty, including:
- Taxpayers with incomes in excess of $250,000 and subject to the Additional Medicare Tax and Net Investment Income Tax
- Taxpayers looking to contribute to traditional or Roth IRAs
- State and local tax deductions in excess of $10,000
- Home mortgage acquisition debt in excess of $750,000
- Taxpayers with long term capital gains and/or qualified dividends
- Taxpayers with long term capital losses
- Spouses with rental properties subject to loss limitations
- Taxpayers collecting Social Security
- Taxpayers subject to the Alternative Minimum Tax (AMT), although much less common under TCJA
- Student loan interest paid in excess of $2,500
- Taxpayers claiming the Earned Income Credit
- Taxpayers wishing to exclude savings bond interest from taxable income
What Provisions Under the TCJA Affect the Marriage Penalty?
Expanded Tax Brackets
While the TCJA provides some relief from the marriage penalty through the expansion of tax brackets, high income married taxpayers are still impacted. Married taxpayers reach the highest 37 percent tax bracket with taxable income of $612,351 for 2019. This is only $100,000 more than threshold for single taxpayers instead of double the single filer threshold of $510,301.
Will and Kate are married, and each has taxable income of $400,000. Thus, their combined taxable income totals $800,000. On a jointly filed 2019 federal income tax return, their joint tax liability would be $234,140. However, if Will and Kate were not married and instead filed two separate returns each with a filing status of single, their combined tax liability would only be $230,387, which is $3,753 less than their joint tax liability of $234,140. The marriage penalty occurs because the marrieds have more of their income taxed at the 37 percent rate ($187,650), while none of the singles' taxable income is taxed at the 37 percent rate, as they are each below the $510,301 single filing status threshold.
Limitations on Deductions
In addition to the impact of the tax rate tables, limitations on certain deductions can also trigger the marriage penalty. For example, under the TCJA, the state and local income tax deduction is limited to $10,000 per return. Thus, married taxpayers can only claim up to $10,000 in state and local taxes, while two single taxpayers can each claim up to $10,000, for a total of $20,000. This results in a marriage penalty through the limitation of this deduction where married taxpayers have paid over $10,000 in state and local taxes.
Also under the TCJA, married taxpayers may be subject to the marriage penalty if they hold large mortgages. A married couple may claim an itemized deduction for mortgage interest paid on up to $750,000 of debt originated after December 14, 2017 ($1 million of debt for debts originated prior to this date). The same limitation applies to single taxpayers. Therefore, two single taxpayers, each with new mortgages in excess of $750,000, could effectively claim double the mortgage interest deduction on individual returns compared to a married couple filing a joint return.
Phaseout of Child Tax Credit
The impact of the TCJA on the marriage penalty isn’t all bad. The TCJA increases the threshold of the phaseout of the child tax credit thereby reducing the impact on the marriage penalty. Prior to 2018, the phaseout of the child tax credit began at $75,000 of adjusted gross income for single taxpayers and $110,000 for married taxpayers, penalizing dual earners each earning in excess of $55,000. Under the TCJA, the child tax credit phaseout now begins at $200,000 for single filers and $400,000 for married filers. By doubling the phaseout range from single to married filers, married filers are now entitled to the same credits as two similarly situated single filers.
Additional Situations Triggering the Marriage Penalty
The head of household filing status continues to intensify the marriage penalty despite the TCJA changes. Where a couple has at least one child, which would entitle at least one taxpayer to file as head of household if they were unmarried, the marriage penalty can become particularly burdensome. The head of household filing status provides more beneficial tax rates and standard deductions than the single filing status, and so one parent being able to claim head of household provides a benefit over filing as two singles. As dual earners generally fare better filing as individuals over married filing jointly, the marriage penalty is even greater should one parent qualify for head of household treatment, across all income levels.
Another “per return” limitation remaining in effect after the TCJA that impacts the marriage penalty is the capital loss deduction. A married couple can deduct capital losses up to $3,000 total. However, the same two persons, if single, could deduct a total of $6,000 ($3,000 each).
Passive activity loss deductions for active rental real estate owners are also higher for two single filers compared to a married couple filing a joint return. A married couple who actively participate in renting out real property can deduct up to $25,000 of loss from the activity, if their modified adjusted gross income is $100,000 or less. If single, each would qualify for up to a $25,000 deduction ($50,000 total) and each could earn $100,000 ($200,000 total).
Finally, the TCJA did not change the 0.9 percent Additional Medicare Tax and the Net Investment Income Tax. Both of these taxes, enacted in 2010, apply to taxpayers with income in excess of $200,000 if single and $250,000 if married filing jointly. Thus, while two taxpayers with incomes of $200,000 each would not be subject to either tax, a married couple with income of $400,000 could be subject to an additional tax of up to $5,700.
What About a Marriage Bonus?
On the other hand, tax can be somewhat lower─a marriage bonus─for some marrieds filing jointly than it would be if they were single. This generally occurs where there is a wide discrepancy in the two individuals' earnings, or when one spouse does not work at all. However, there is no universal rule as to when this applies.
The marriage penalty is alive and well after the TCJA. For taxpayers with two incomes, state and local tax deductions, home mortgage interest, rental losses, capital losses, children or incomes over $250,000, the marriage penalty will almost always apply. Complete elimination of the marriage penalty would require a further and meaningful overhaul of the tax code, which we do not foresee in the near future. What we do foresee is a significant opportunity for tax planning for those contemplating marriage (as well as divorce), so be sure to include tax planning in your marriage plans.
For Further Information
If you would like more information about this topic or your own unique situation, please contact John I. Frederick, JD, LLM, Steven M. Packer, CPA, or any of the practitioners in the Tax Accounting Group. For information about other tax and accounting topics, please visit our publications page.
Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.