An examination of married joint and separate filing status

0
by on November 9, 2010 at 12:32 am

With this ring we pay less?

It was July…. Hot summer day. I was in my office trying to close out a couple of projects… Hoping to get to the marina before 6… My phone rings. I’ll never forget. It was one of my clients mothers. She had her daughter on the other line. I’d known her daughter for several years. Smart girl. Loved her career. Took advantage of its’ uniqueness. Bought a rental property at her favorite ski hole. Took the time to enjoy the opportunities shipping provided.

Why was mom calling?

“I need you to do me a favor.” she said. “Can you please explain to her how much she would save in taxes if she got married!!!”

Tricky situation for anyone to be put in. Professionally, I have an obligation to provide an informed opinion within my profession. “What does he do for a living?” I ask. “He sails out too… We make about the same…” she said. “Well then, getting married will probably make the tax burden a little worse.”….

“What!!!” mom screamed, as her plan was crashing through the floorboards. “I’m sorry” I said, “but these two are already prime candidates for the marriage penalty”.

What is the marriage penalty?

In the beginning – which is 1913 from the Federal Income Tax perspective, there was a general “bucket” for all types of taxpayers – be it single, head of household, married, etc… There have been many changes to the structure of filing status for the income tax over the years. Our current revision of filing types took form under tricky Dick in 1970.

Point being, married status was made during a different period. In 1970 $10,000 was a fair salary, a high end Ford Mustang convertible ran about $4,000, a new house was about $23,000, and e-mail was a postage class… There was one other aspect that plays a key role from the tax perspective – a married household had one wage earner on average. The structure of filing married was developed under the assumption that only one spouse worked.

Back then if I earned the average household income of $10,000, I could have owned the house and the Mustang outright in less than 3 years. Now days we have an average household income of $50,000, a high end Mustang runs $40,000, and a new house (sparingly) runs at $250,000. The same purchase will take just short of six years. The time to acquire the assets has doubled. This is one reason that everyone works in 93% of modern American households.

Pitfalls of married joint

A single income household will recognize a large benefit from filing married jointly. The tax rates are lower, threshold phase outs for many credits and deductions are higher, refundable credit allowances are higher, etc…

Three big issues -

  1. When we combine a two income household, one income gets stacked on top of the first – meaning it will be taxed very aggressively. It can effectively neutralize the benefit of the lower tax brackets.
  2. The higher phase outs for credits and deductions is not “twice” as big as it would be if you were single. Generally the factor used is 1.5 – meaning a dual income household will pass the phase out point quicker than comparable single filers.
  3. We don’t get a higher range or phaseout on everything. Two examples are capital and passive losses. If we sell stock and have a net capital loss of $50,000, we can deduct a maximum of $3,000 annually – single or married…. Passive loss limitations stay at $25,000 regardless as well.

So I’ll Just File Married Single?

Not the same. A common misconception. First, there is no married filing single status. It is married filing separate. Second, it is not the same as filing single. Deductions and phase out limitations have to be allocated between the two separate returns. It is generally more expensive to file this way.

The main reason couples file married separate is that they do not want to have any involvement in their spouses financial or tax matters – aka married Tony Soprano :)

When does it become a concern

We could fill books with statistics and histories. Here’s the readers digest approach… If both spouses work, things will get more difficult past an AGI of $110,000 and will be outright miserable as you approach and pass $200,000.

So start planning now. See what you can do to offset income before it becomes an issue. Just like sailing – preventative maintenance eliminates the need for damage control.

Leave a Reply

Your email address will not be published. Required fields are marked *