We’ve all heard of the so-called “marriage penalty”, but what exactly does that term mean? The marriage penalty (or, in rare cases, a marriage bonus) occurs when you combine two separate incomes on a joint return and obtain a different result (usually worse) than filing two incomes as single individuals.
Even for those with very modest incomes, the tax code contains a strong bias against families and joint filing. We’ll show you how with a couple of uncomplicated illustrations in the table below.
By uncomplicated we mean that in the table below the clients are:
- Using the standard deduction,
- Have only wage income,
- Claiming any and all dependents, credits, etc.,they were entitled to claim,
- Using the Head of Household status to the maximum advantage.
BTW-If you think what happens below is bad, just wait until we get to the items that cause married couples to incur phaseouts and disallowances that can create marginal Federal rates of 60% or more! Consider the case of Jim and Mary. What happens when they marry and file jointly? The bottom line result is outlined below.
||Marriage Penalty or (Bonus)
|$150,000||$150,000 (no children)||Marriage Penalty=$3,806.50|
||$15,000 (with one child)||Marriage Penalty=$1,087.88|
||$50,000 (no children)||Marriage Bonus=($225)|
Now let’s complicate the problem. As we predicted above – it gets much worse.
Among the items that can be disallowed at a different level of income on a joint return are:
and those are just a sampling of the tax code traps lurking for Jim and Mary.
Because this can get really technical, we’ve whipped up a color-coded chart to help you navigate your way through this maze.
You only have to remember one thing – stay out of the red! (Wouldn’t it be nice if Washington could understand that simple concept?)
The darker the red area that contains your income – the worse the penalty. Conversely, any blue area is good for you. The darker blues indicate a marriage “bonus” zone.
Once you locate your joint income across the top of the chart, then use the vertical axis for the percentage of your spouse’s income to total income and you’re done.
How’d you do?
I wasn’t kidding about the modest amount of income that can cause a penalty. Via the chart, you can see that a red section begins with less than 20,000 of joint income.
It’s an interesting insight into Congress’ intent when you look at the same data but for a joint return without any children. Notice that the red portion of the chart is much smaller?
Once you have the data, it’s pretty clear who Congress wants to reward and who they want to penalize.
When Karl Marx wrote the Ten Planks of the Communist Manifesto, plank number two was “ a heavy progressive or graduated income tax.” Astute readers of the charts can see why a socialist would desire this.
Now that we’ve stated the problem, how about some solutions? Scroll down to below the second chart and we’ll discuss.
(Click the chart for a larger version)
Penalty/Bonus -Joint income without children.
Now that we know the problem is combined income along with certain tax traps (deduction phaseouts, etc.), we can work on a solution.
Look back to the list above , and you’ll see our partial list of items that cause this anti-family bias. The secret to fighting back is to reduce your exposure in one (or more) of these areas.
Let’s look at an example or two. I’ll pick some items from the list and discuss how to lessen the effect.
Alternative Minimum Tax (AMT)- Dozens of items can cause or add to an AMT problem that all start with Adjusted Gross Income (AGI) as their base. Therefore, lowering AGI can help to relieve the amount of this tax. Increasing your 401(k) contribution, losses from self-employment, and other page 1 deductions can shrink an AMT problem down to a livable size.
Educational Credits and Deduction- This reduction is usually triggered by the amount of taxable income. One solution is to arrange your affairs so that your child can take the credit. With the child’s lower income the limitation is usually not a problem. The details on this are too lengthy to go into here, but it could start with your employing your child in the family business and paying them for work performed. See our tips on keeping the wealth “All in the Family” for more information. In some cases, electing not to take the credit but to utilize the tuition deduction instead may prevent you from losing some of the benefit.
The point to remember is that for every tax problem – there can be a beneficial strategy. Sometimes, and in some areas, it’s not cost effective to implement them all, but we never want a client to leave “money on the table” when it comes to their return.
Existing clients are welcome to call us for a review of their return. If you’d like this kind of service, but don’t feel like you’re getting it, perhaps you should consider a change.
Remember that we’re just a click away when you need help.
He is also a founding Board Member and Finance Director of the Fayette Pregnancy Resource Center and serves on the Board of the National Equal Rights Institute.