When a taxpayer becomes married, his or her tax filing status will change. This change in filing status can have significant implications on tax liability, both for the good and bad. A taxpayer’s filing status for the year is determined on the last day of the tax year. Therefore, even if a taxpayer is single for the majority of the year but gets married before the close of the year, he or she must file as a married individual for the entire year. It is not uncommon for tax professionals to recommend waiting until after the close of a tax year to get married. Once a taxpayer is married, he or she must choose between one of the following options:
- File a joint return where the couple’s incomes and deductions are combined and all the tax limitations and benefits apply to them jointly, or
- File as married individuals filing separately, which may or may not provide any tax benefit. This may cause a larger combined tax than filing a joint tax return, since the tax code includes penalties to prevent married taxpayers from gaining any tax advantage by filing separately.
There is no magic wand to determine what the impact will be on an individual’s tax liability once he or she gets married. It is complicated because the tax code includes a vast number of adjustments that must be made to the tax return based upon the taxpayer’s marital status, income, deductions, exemptions, credits, etc. The only thing that can be done is to make a careful evaluation of all the issues that are unique to each of the individuals entering into the marriage.
Although the tax code is riddled with factors that are related to marriage, the principal ones are summarized below:
- Tax Rates
- Phase-Out IRA Limits
- Social Security Taxation
- Home Sale Issues
- Allocation of Tax Due & Refunds
- Passive Loss Limits
- Education Credits
- Child Care Credits
- Home Mortgage Interest
- Beneficiaries, Title to Property and Wills
- Capital Gains & CG Rates
- Taxation on Dependent Children
Tax Rates – Each filing status has a different tax rate schedule based upon taxable income. As the taxable income increases, so do the tax rates for that marital status. This can create some unexpected results, especially when both taxpayers have income. For example, let’s consider a couple where only one has taxable income; prior to marrying, the filer uses the single status and rates, but once they are wed, lower joint tax rates will be used for the same income and a lower overall tax can be anticipated. On the other hand, if both have income, that income must be combined to determine the couple’s joint tax rate; this can throw them into a higher tax bracket, resulting in a larger tax bite than if they been able to file as single individuals. In addition, the tax rates are determined from taxable income which can be affected by a variety of other factors listed below.
Deductions – Both single and married individuals can choose to use the standard deduction or itemize their deductions. However, once they are married, this option is only available to the couple jointly. Prior to marriage, both could claim the standard deduction or one could claim the standard allowance and the other could itemize, but while married they must choose one or the other. The result can be a significant loss of deductions for the year. This, in turn, can lead to a higher taxable income and thus increased tax. A married couple cannot get around this problem by filing married separate returns, since the tax code requires both to itemize their deductions if either of the couple itemizes.
Some itemized deductions are required to be reduced by a percentage of adjusted gross income. For example, in 2011, only medical expenses in excess of 7.5% of AGI are deductible. Also, there is an overall itemized deduction limitation based on AGI that applies to higher-income taxpayers. Because the joint return of a married couple combines their incomes, the allowed deductions may end up being less than if the couple could file as unmarried individuals. Take for example an individual with AGI of $40,000 and $5,000 of medical expenses. If unmarried, she would include $2,000 of the medical expenses as part of her itemized deduction total ($5,000 – ($40,000 x 7.5%)). If this individual married during the year and her spouse also had income of $40,000 but no medical expenses, they would not be able to deduct any of her medical costs because 7.5% of their combined $80,000 AGI is $6,000, which exceeds the $5,000 of expenses.
IRA Limits – A contribution to a Traditional IRA may not be tax deductible, if the taxpayer or his or her spouse has a retirement plan where they work and their income exceeds a certain amount. Contributions to Roth IRAs may be prohibited altogether depending on income level. Because of these factors, newly married individuals may find that they are no longer eligible to take a deduction for a contribution to a Traditional IRA or contribute to a Roth IRA. This can be especially troublesome for a taxpayer who already made a contribution for the year, based upon their individual income and unmarried status, and then subsequently marries in the same year.
Social Security Benefits Taxation – For lower-income individuals, Social Security (SS) income may be tax-free. However, as a taxpayer’s income increases, the SS income becomes taxable. The threshold for the taxability of the SS income is $25,000 for single individuals and $32,000 for married individuals filing jointly. Combining the incomes of individuals who were previously filing as unmarried and now file jointly generally causes more of the SS income to be taxable. Married individuals who lived together at any time during the year and who file using the married separate status have a zero threshold before their SS income becomes taxable, so there is a major disadvantage to filing separate returns for SS recipients.
Home Sale Issues – A taxpayer who sells his or her main residence after owning and using it as their primary residence for two out of five years prior to the sale qualifies for a $250,000 gain exclusion. Even if the two-out-of-five rule isn’t met, the taxpayer could qualify for a partial gain exclusion. When a couple files a return and they both meet the two-out-of-five-years use requirement, they each qualify for a $250,000 exclusion, thus doubling the excludable amount to $500,000. Where only one spouse owned a home prior to the marriage and would only qualify for a $250,000 exclusion, the couple would qualify for a $500,000 exclusion after marriage once the spouse without a home meets the two-year use requirement.
Where both spouses owned a home before getting married, they can sell either or both of the homes and each benefit from a $250,000 exclusion. There are a number of complications that can be encountered with the complex home sale laws, so be sure to consult with this office prior to taking any home sale actions.
Allocation of Tax Due & Refunds – Married individuals combine their income, deductions, credits, etc., when filing jointly. If there is a refund, it is issued as a single check. Couples who maintain separate funds and accounting will have to determine how to allocate the refund between them. On the other hand, if there is a tax due, the government treats that tax due as a joint liability. If it is not paid, the couple will be pursued both jointly and individually for tax liability.
Where an individual has a tax liability prior to marriage and then files jointly after marriage, the refund from the jointly-filed return can be withheld to pay the spouse’s prior tax liability.
Passive Loss Limits – Where taxpayers have passive losses, most typically from operating rental property, only $25,000 of the losses can be deducted each year (after offsetting any passive income). In addition, the $25,000 maximum loss allowance is phased out for higher-income taxpayers. The phase-out AGI threshold is $100,000 and fully phased out at $150,000. Where both of the taxpayers own rental property, they essentially combine their passive income by getting married. This could cause them to exceed the $25,000 loss limit or increase their income, causing the $25,000 loss limit to be reduced and, in doing so, reduce the amount that can be deducted for the year. On the other hand, if one of them has losses and the other spouse’s passive income is positive, they would be able to offset the one spouse’s passive income with the other’s passive losses. The $25,000 loss allowance is not available to married taxpayers who file separate returns and who lived with their spouse at any time during the tax year.
There are a number of possible scenarios relating to combining passive income and losses that can have a significant impact after marriage. Contact this office to determine the impact based on your particular circumstances.
Education Credits – There are two education credit limitations that can come into play because of marriage:
• The American Opportunity and Lifetime credits are phased out for higher-income taxpayers. Thus, combining incomes on a joint return may cause credits that were allowed as an unmarried individual to be phased out.
• The Lifetime Learning Credit is limited annually to $2,000 per family. Thus, married taxpayers can qualify for only a maximum credit of $2,000, where prior to marriage they could qualify for up to $2,000 each.
Child Care Credits – Where either or both individuals have child or dependent care expenses, getting married can result in some significant changes in the amount of the child care credit.
• Generally, married taxpayers qualify for the credit only if both spouses are employed. There are exceptions for disabled and student spouses. Thus, if only one has care expenses that would have qualified for the credit prior to marriage, those expenses will not qualify when filing jointly.
• The credit, which ranges from 35% to 20% of the care expense, is also reduced for higher-income taxpayers. So by combining incomes on a joint return, it may reduce the credit amount.
• The expenses subject to the child credit are limited to $3,000 for one child and $6,000 for two. Thus, married taxpayers can qualify for only a maximum of $6,000 of expenses, compared to $6,000 for each individual prior to getting married.
Home Mortgage Interest – Generally, home mortgage interest is only deductible on $1 million of home acquisition debt plus $100,000 of home equity debt. Where a couple both owned a home before marriage, they may possibly exceed those limits on their combined homes and, as a result, have a portion of their home mortgage interest deduction disallowed.
Beneficiaries, Title to Property and Wills – Many unmarried individuals will have a parent, sibling, child or other relative designated as the beneficiary for their IRAs, annuities, pension plans and insurance policies. They may also hold title to property in some form of joint ownership with an individual other than their new spouse. These items, and wills and trusts that were drawn up as an unmarried individual, should be reviewed and amended accordingly.
Capital Gains & CG Rates – Capital gains rates are income dependent. Rates are currently 0% and 15% depending on a taxpayer’s taxable income. Thus, a married couple with combined incomes could be subject to a higher capital gains tax than they would have had filing as unmarried. Therefore, consideration for selling capital assets in the year prior to marriage may be appropriate, especially if the one with the potential sale has little other income.
Taxation on Dependent Children – Some years ago, Congress created what is referred to as the “Kiddie Tax” to discourage taxpayers from placing their investment accounts under their child’s name to take advantage of a child’s lower tax bracket. Thus, children are generally taxed on most of their investment income at their parent’s marginal tax rate. A result of combining newlyweds’ incomes on a joint return may be that the tax of a child subject to the Kiddie Tax rules is increased as well.
It may be appropriate to consult with this office before tying the knot to make sure that the tax aspects based on your particular issues are fully understood.