The marriage penalty after the JGTRRA.

Although recent marriage penalty reforms may not affect a couple's decision to marry, knowledge of the provisions might be useful in budgeting and planning. This article discusses recent reforms and the remaining penalty and bonus provisions, and provides examples of how they affect married taxpayers in various situations.

In the greater scheme of things, marital status would not seem to be a reasonable determinant of tax burden, nor tax burden a factor in the decision to marry or not. However, for many years, Congress has grappled with this linkage. At present, the tax system is not marriage neutral; a married couple's tax liability has long differed from the combined tax liabilities of two similarly situated unmarried individuals. Although relatively small differences in tax liability might not affect a couple's decision to marry or not, information on the couple's individual and married tax liabilities might help in budgeting and even affect the timing of a marriage.

The "marriage penalty" has been the subject of much public discussion and many bills introduced in Congress. Demographic changes have intensified the importance of this issue and led to small, quick fixes in the tax law, the most recent being the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). This article analyzes the effect of recent marriage penalty reforms, situations in which the penalty still exists and marriage and divorce bonuses allowed by the Code's current bracket structure.

Background

One goal of taxation is fair distribution of the cost of government by income classes (vertical equity) and among people in approximately the same economic circumstances (horizontal equity). Vertical equity would require individuals with a greater ability to pay to shoulder a greater tax burden than others less able. On the other hand, horizontal equity would require two individuals with equal incomes to pay equal taxes. Based on horizontal equity, a married couple and two single individuals with equal incomes should have the same tax liability. To maintain vertical equity, married individual would pay lower taxes because of the financial burden of caring for a family. These competing objectives may have been easier to achieve when the traditional wage earner was a married male with a wife who did not earn income. However, the American family now includes two earner families, single parents, traditional families and many variations. Congress has continually responded to equity issues by amending the tax law to accommodate the changing composition of the taxpaying public.

Since 1969, when the single rate schedule was restructured so that a single person's tax would never exceed 120% of the tax of a married couple with the same income, there has been some form of marriage penalty. Through the years, it has been amplified and deminished, but never eliminated, by various Code changes.

Recent Reforms

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) was a step toward eliminating the marriage penalty. It phased in (1) an increase to the standard deduction for married filing jointly (MFJ) to twice that of a single taxpayer by 2009, (2) an increase in the 15% bracket for MFJ to twice that of a single taxpayer by 2008 and (3) changes to the earned income credit.

Under the JGTRRA, however, the doubling of the basic standard deduction and the 15% bracket for MFJ was accelerated to 2003 and 2004. However, these JGTRRA provisions apply only to those years. After that, the basic standard deduction and the 15% bracket return to the amounts scheduled under the EGTRRA for a couple filing jointly. The basic standard deduction for joint fliers or a surviving spouse, as a percentage of the dollar amount for a single return, is set forth in Sec. 63(c)(7):

              % of single
Tax year   standard deduction
2003              200
2004              200
2005              174
2006              184
2007              187
2008              190
2009 and after    200

In 2004, the basic standard deduction for single returns is $4,850 and $9,700 for joint returns and surviving spouses (200% X $4,850). For 2003, the single basic standard deduction was $4,750 and $9,500 for joint returns and surviving spouses (200% x $4,750). The additional standard deduction (for those 65 and older) is not affected by the JGTRRA. For married individuals and surviving spouses, that amount is $950 for both 2004 and 2003; for single taxpayers, it was $1,150 for 2003 and is $1,200 for 2004.

Effect of Marriage Penalty Reform

The marriage penalty caused by standard deductions and the width of the 15% brackets is eliminated for some taxpayers for 2003 and 2004. For a couple with equal incomes and an aggregate income not exceeding the 15% bracket's upper limit for joint filers, the joint liability is exactly the same as for two single individual filers.

Example 1: Mr. B and Ms W are considering marriage, but are concerned about the marriage penalty. B and W each have adjusted gross income (AGI) of $66,575. Thus, the individual single tax liabilities for 2004 would be $11,394.

AGI                   $66,575
Less:
Standard deduction      4,850
Exemption               3,100
Taxable income        $58,625
Tax                   $11,394
x 2                   $22,788

If B and W marry, their combined joint filing liability would be $2,788--exactly twice the single liability:

AGI                  $133,150
Less:
Standard deduction      9,700
Exemption               6,200
Taxable income       $117,250
Tax                   $22,788

Higher-income couples: When a married couple's aggregate AGI exceeds the upper limit of the joint 15% bracket, the marriage penalty still exists. Exhibit 1 on p.285 shows how the MFJ tax liability exceeds the combined single tax liabilities, as AGI increases for a couple with equal incomes. Notably, personal exemptions must be phased out at higher income--for 2004, AGI exceeding $142,700 for singles and $214,050 for MFJ. (1)

Timing deductions: Although the JGTRRA's marriage penalty relief is short term, there are ways to make the most of its benefits. Depending on a couple's level of itemized deductions, it may be wise to accelerate as many itemized deductions as possible into one tax year. For cash-basis taxpayers, the timing of payment determines the deduction year. Many deductions (e.g., properly taxes, state income taxes, charitable contributions and some medical expenses) are somewhat flexible. The benefit resulting from the double standard deduction could be realized in one year, in addition to a larger itemized deduction in the next year.

Example 2: Mr. and Mrs. B have AGI of $139,000 and file a joint return. They normally have property taxes of $2,500 in December, $7,000 of qualified residence interest and make $1,000 in cash charitable contributions each year. To take advantage of the double standard deduction in 2004, the Bs pay their property, taxes in January 2005, rather than December 2004. They will pay new year's property taxes in December 2005. In addition, they will postpone their 2004 charitable contributions until January 2005.

                     2003     2004      2005

Property taxes      $2,500       $0    $5,000
Interest             7,000    7,000     7,000
Charitable
  contributions      1,000        0     2,000
Total deductions   $10,500   $7,000   $14,000

This treatment allows the Bs to deduct $10,500 in itemized deductions in 2003 and $14,000 in 2005, and to take the $9,700 standard deduction in 2004. Their taxable income is reduced ill 2005 by the additional itemized deductions and they also benefit from the double standard deduction in 2004.

Marriage and Divorce Bonuses

There is still a marriage bonus when one spouse is the sole income provider. This bonus is smaller if both spouses have income, but one spouse makes a great deal more than the other. Exhibit 2 above illustrates the marriage bonus at different income levels, with one spouse providing all of the income. Again, personal exemptions must be phased out at higher income levels--i.e., for 2004, AGI exceeding $142,700 for singles and $214,050 for MFJ.

The JGTRRA did not change the head-of-household tax rates. Consequently, there is a divorce bonus when a couple has children who continue to live with one or more of the former spouses, or when one or both of the former spouses can file as a head of household after the divorce. Exhibit 3 on p. 288 shows the bonus when a couple has two children and, after divorcing, one child lives with each former spouse. More commonly, when both children live with one of the former spouses, the bonus is smaller, because the former spouse with no children in the home would file as a single individual.

Remaining Marriage Penalty Provisions

Many provisions in the tax law still cause a marriage penalty; many phaseouts still provide an advantage to single individuals. In January 1998, the AICPA issued a phaseout simplification proposal, titled "AICPA Legislative Simplification Proposal on Phase outs Based on Income Level." (2) The proposal identified 20 phaseouts in the current law in which the total of two single individuals' phaseout amounts did not equal a married couple's phaseout amounts. Many of these provisions still exist.

For example, the phaseout for personal exemptions begins at $214,050 for a MFJ couple and at $142,700 for a single individual. (3) Another example is the amount of Social Security included in gross income. When coupled with the differences in the additional standard deduction, many older taxpayers are still suffering a marriage penalty.

Example 3: Mr. S and Ms. J, both 67, are considering marriage. They each have $10,000 of interest income, $20,000 in retirement plan income and $10,000 of Social Security benefits. As single individuals, they would each have a 2004 tax liability of $3,573, with a combined liability of $7,146, computed as follows:

Interest income                            $10,000
Retirement income                          20,000
Social security included in gross income    5,350
Less:
Standard deduction                          6,050
Personal exemption                          3,100
Taxable income                             $26,200
Tax liability                              $3,573

Social Security included in gross income:

Lesser of:
One half of $10,000 = $5,000
One half of ($10,000 + 20,000 + 0.5($10,000) -
  $25,000) + $5,000

Lesser of:
1.85% of $10,000 = $8,500, or the

2. Sum of:
85% of ($10,000 + 20,000 + 0.5($10,000) -
  $34,000) = $850, and

Lesser of $5,000 or $4,500 = $4,500
Sum = $5,350

As a married couple, the tax liability would be $8,275, computed as follows:

Interest income                            $20,000
Retirement income                          40,000
Social security included in gross income   17,000
Less:
Standard deduction                         11,600
Personal exemption                          6,200
Taxable income                             $59,200
Tax liability                              $8,275

Social Security included in gross income:

Lesser of:
One half of $20,000 = $10,000
One half of ($20,000 = + 40,000 +0.5($20,000) -
  $32,000) = $19,000

Lesser of:
1.85% of $20,000 = $17,000, or the

2. Sum of:
85% of ($20,000 + 40,000 + 0.5($20,000) -
  $44,000) = $22,100, and
Lesser of $10,000 or $6,000 = $6,000
Sum = $28,100

For some taxpayers, the difference ($8,275 - 7,146 = $1,129) might make it worth putting off marriage until early January of 2005.

Conclusion

Couples contemplating marriage or divorce may want to consider the effects of the marriage penalty, and the JGTRRA's temporary relief. Although taxes may not be a major concern, saving money is always an incentive. Tinting a wedding or divorce to get the most benefit from the tax law may seem a bit callous, but is definitely practical. One foolproof method of avoiding the marriage penalty is not to get married. However, in addition to possible emotional, social and religious stigma, tiffs strategy prevents couples from taking advantage of some marriage-friendly tax provisions, such as those for estate and gift taxes. At a minimum, all married taxpayers should project the tax savings brought about by the JGTRRA and reduce their withholding or estimated tax payments accordingly.

Although innumerable tax provisions still relate to marital status, the JGTRRA accelerated the penalty relief to married taxpayers through a doubled standard deduction and 15% rate bracket. The tax law is still far from marriage neutral. However, Congress has not lost sight of the goal of distributing the cost of government fairly and continues to strive for equity.

Exhibit 1: Marriage penalty for higher incomes (in $)

    Single--equal incomes            MFJ
                                                 Marriage
  AGI       Tax     Tax x 2     AGI      Tax     penalty

 87,500    16,901    33,801   175,000   34,506        704
100,000    20,401    40,802   200,000   41,778        976
200,000    51,137   102,273   400,000  111,248      8,975
400,000   119,210   238,420   800,000  251,248     12,828

Exhibit 2: Marriage bonus for one-income couples (in $)

Single--one incomes   MFJ
                                        Marriage
  AGI       Tax       AGI       Tax       bonus

133,150    29,683   133,150    22,788     6,895
175,000    42,682   175,000    34,506     8,176
200,000    51,137   200,000    41,778     9,359
400,000   119,210   400,000   111,248     7,962
800,000   259,210   800,000   251,248     7,962

Exhibit 3: Divorce bonus for couples with two children (in $)

Head of household--equal incomes   MFJ
                                                    Divorce
  AGI        Tax      Tax x 2      AGI      Tax      bonus

  87,500     14,138     28,276   175,000   32,770      4,494
 100,000     17,263     34,526   200,000   39,770      5,244
 200,000     46,413     92,826   400,000  111,248     18,422
 400,000    115,566    231,132   800,000  251,248     20,116

Karyn Bybee Friske, Ph.D., CPA Associate Professor of Accounting Department of Accounting, Economics and Finance West Texas A&M University Canyon, TX

Darlene Pulliam, Ph.D., CPA Professor of Accounting Department of Accounting, Economics and Finance West Texas A&M University Canyon, TX