The Marriage Penalty after the JGTRRA

Although recent marriage penalty reforms may not affect a couples 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.

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

For more information about this article, please contact Dr. Friske at kfriske@mail.wtamu.edu.

Executive Summary

• The JGTRRA temporarily increased the standard deduction and the 15% bracket for joint filers to twice that of a single taxpayer.

• A marriage penalty still applies to many joint filers with income exceeding the 15% bracket, and many phaseouts still favor the single taxpayer.

• A marriage bonus exists when one spouse provides most or all of the income; a divorce bonus applies in certain 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 couples 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 couples decision to marry or not, information on the couples 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 Codes 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 individuals 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 persons 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 diminished, 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 filers or a surviving spouse, as a percentage of the dollar amount for a single return, is set forth in Sec. 63(c)(7):

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% brackets 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.

If B and W marry, their combined joint filing liability would be $22,788exactly twice the single liability:

Higher-income couples: When a married couples aggregate AGI exceeds the upper limit of the joint 15% bracket, the marriage penalty still exists. Exhibit 1 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 incomefor 2004, AGI exceeding $142,700 for singles and $214,050 for MFJ.¹

Timing deductions: Although the JGTRRAs marriage penalty relief is short-term, there are ways to make the most of its benefits. Depending on a couples 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., property 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 next years property taxes in December 2005. In addition, they will postpone their 2004 charitable contributions until January 2005.

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 in 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 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 levelsi.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. Con-
sequently, 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  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 couples 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:

Social Security included in gross income:

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

Social Security included in gross income:

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 JGTRRAs temporary relief. Although taxes may not be a major concern, saving money is always an incentive. Timing 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, this 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.