The wedding bells are ringing, waves are crashing onshore at your honeymoon in Hawaii, and then it hits you! How is getting married going to affect my taxes? Okay, so maybe no one is thinking about taxes on their honeymoon, but it is something that every couple should understand. The tax system of the United States is setup so that combined tax liability of a married couple may be higher or lower than their combined tax bill if the couple had remained single.
This is where the idea of marriage penalty and marriage bonus comes from. The marriage penalty often affects taxpayers that have very high and very low incomes, and the marriage bonus affects several middle-income couples who have disparate incomes. The extent to which the marriage penalty or bonus affects a given couple depends on factors such as the level of their combined income, the proportion of their individual incomes being similar, and how many children they have.
A marriage bonus typically occurs when one individual with a higher income marries and files a joint return with an individual who has a much smaller income, and the additional income is not usually enough to push the combined income into a higher tax bracket. Married couples fall into the married filing joint tax brackets, which are wider in terms of income limits and result in a lower tax bill.
A marriage penalty occurs when two individuals with equal incomes marry and relates to individuals who have very low and high incomes. A high-income couple falls into this trap because income tax brackets for married couples at the top of the income tax schedule are not twice as wide as the equivalent brackets for single filers.
An example is the 33% tax bracket, which for 2015 single filers start out at $189,301, but for married filing joint filers it starts out at $230,451. Two high incomes when combined could easily put a couple’s income into a higher bracket than filing as single, thus resulting in a penalty.
Another item to consider for the marriage penalty with high-income earners is the new 3.8% investment income tax. This tax is imposed on single filers who have adjusted gross income of $200,000 or more and for married filers with gross income of $250,000.
Two individuals who both made $150,000 would not be subject to the net investment income tax if filing as single. But if these two filed as married they would be subject to the additional tax, which is the lesser of their net investment income or the amount of their adjusted gross income over the threshold, times 3.8%.
When else can a penalty occur?
A marriage penalty can also occur when two low-income individuals file as married. Two individuals who file single can be eligible for a large earned income credit depending on how many children they have to claim. The other advantage of claiming a dependent is the opportunity to file as head of household instead of just single. Head of household tax brackets are wider and there is also a larger standard deduction. Filing married eliminates the benefits of head of household and could potentially lower the amount of earned income credit available due to the combined incomes.
So what options do we have?
The idea of a marriage penalty or bonus causing a couple to tie the knot or to wait it out seems extraordinary, but it could affect one’s decision to work, work less, or not work at all. A married couple could have one individual who makes $40,000 and falls into the 25% tax bracket filing single, but who would fall into the 15% tax bracket filing married. The reverse could be true for the other spouse who didn’t work as single and would have been in the 0% bracket, but then married if they decided to work could possibly be in the 15% to 25% bracket.
Will the US ever change this policy?
There are ways to eliminate the marriage penalty and bonus, but it would require large changes to the US tax code. The US tax code is designed to be progressive in nature, but to also be equal in treatment among married and unmarried couples. If the United States adopted a flat tax and removed all provisions, then the marriage penalties and bonuses could be elmiminated. The United States could also eliminate the marriage penalty and bonus by keeping the progressive tax structure, but requiring everyone to file single. Without a major overhaul of the United States tax code, solutions such as widening the tax brackets for high-income earners filing joint and a permanent extension of the marriage penalty relief of the Earned Income Tax Credit will have to suffice as potential short term solutions.