The Marriage Tax Penalty

Marriage Tax Penalty

The concept of the "marriage tax penalty" is a critical issue for many couples, affecting their financial planning and tax filings. The marriage tax penalty occurs when a married couple pays more in taxes than they would if they were filing as single individuals. 

The marriage tax exists when the income thresholds for tax brackets for married couples filing jointly are not simply double those of single filers. For example, a single individual might fall into a higher tax bracket only after reaching a certain level of income, whereas a married couple filing jointly might hit this higher bracket with their combined incomes at a lower threshold per person, leading to a higher effective tax rate on their combined income than they would face individually as single filers. This bracket mismatch means that as each partner's income increases, the couple's combined taxable income may push them into higher tax brackets more rapidly than if they were taxed individually, exacerbating the financial impact of the marriage penalty. This structural feature of the tax code thus disproportionately affects dual-income couples, especially those where each partner earns a similar amount, leading to a higher tax burden than if they were assessed as single taxpayers.

This issue can manifest at both federal and state levels, with particular implications for at the state level after improvements to the Federal tax code. Understanding the nuances of this penalty is essential for couples as they navigate their tax obligations and seek opportunities for tax planning and savings.
 

Federal Level Implications

At the federal level, the tax brackets and rates are structured in a way that can lead to the marriage penalty, especially for dual-income couples. The tax brackets for married couples filing jointly are not always double those of single filers, particularly in the higher income brackets. This discrepancy means that couples with similar or high incomes can end up paying more in taxes when they file jointly than they would as two single individuals.

The Tax Cuts and Jobs Act (TCJA) of 2017 made significant changes to the tax code, including adjustments to tax brackets and rates, which aimed to mitigate the marriage tax penalty for many couples. However, it didn't eliminate the penalty entirely, especially for couples in the higher income brackets. 

See below for the 2024 Tax Brackets:

For the federal tax rates you can see that the marriage tax penalty hits the higher income brackets –the bracket stops doubling at 35%.  Let’s examine a couple that both make their income from a jointly owned small business and each pay themselves $400,000 for a combined household income of $800,000.   If they filed individually,  $156,724 ($313,448 total) would be subject to a marginal tax rate of 35% for a cost of $109,796.  If they filed married filing jointly, $243,749 would be subject to a marginal tax rate of 35% and $68,799 would be subject to the higher 37% bracket for a total cost of $110,767.78 resulting in a penalty of $971.78.  This penalty would increase as the small business income paid out increases.

The standard deduction for married filing jointly is double that for single filers, which can provide some relief, but the benefits can be offset by the bracket disparities for high earners, including the imposition of the Alternative Minimum Tax (which we will likely cover in a later article).

Although this article is focused on the income tax, the same problem exists with FICA taxes because these income brackets for married filers are not precisely double those of single filers for FICA income phase-outs. This discrepancy is especially pronounced for couples who are self-employed or receive income not subject to withholding, as they are responsible for both the employee and employer portions of FICA taxes. 
 

State Level Dynamics

With the improvements in the federal tax rate, the Marriage Tax penalty has largely become a state issue.  As anyone with a passing familiarity with the news can attest, the states have VERY different views on many things and the imposition and administration of taxes is one of them.  

For example in Harmony’s neighborhood both DC and Virginia don’t have any relief for married taxpayers meaning they are subject to the full penalty on all income taxed at the state level. 

Maryland does provide some forms of tax abatement; however, it does not mirror the federal practice of doubling the majority of tax brackets for married couples who file jointly. Unlike the more generous federal structure (until you reach the higher levels), Maryland's approach to joint filings for married couples does not offer the same level of benefit.

Navigating the Marriage Tax Penalty

Understanding and navigating the marriage tax penalty requires careful consideration of a couple’s financial situation and tax planning strategies. 

The marriage tax penalty is a complex issue that can significantly impact married couples, especially those with high combined incomes. By understanding the federal and state tax implications, couples can better navigate their tax obligations. Consulting with your Harmony tax professional and engaging in proactive tax planning are key steps in mitigating the impact of the marriage tax penalty and optimizing financial health.

Journal Entries

March 2024

The ____ is Too Damn High?

It seems a weird phenomenon – inflation has seemingly cooled down to 3.2% after hitting a peak of 9.1% in 2022  (total pre-pandemic inflation 20%)  but when you talk to a lot of people it sure seems like things got much more expensive even with real wage growth.  We aren’t talking about shrinkflation, added fees or any other tools companies used to combat rising prices. Taking out our tinfoil hat, maybe the numbers aren’t real? We aren’t saying that anything conspiratorial is afoot but the government changes the inputs of the Consumer Price Index and using some older methodologies show much higher inflation. Perhaps these changes can explain the dissonance a lot of people are feeling when everything seems much more expensive while we are bombarded with news how the economy has recovered?
 

Corporate Minimum Tax First Year

In its inaugural year, President Biden's 15% corporate alternative minimum tax (CAMT), introduced through the 2022 Inflation Reduction Act, targeted large companies like Duke Energy, Whirlpool, KKR, and Blackstone to address the discrepancy between reported profits and minimal corporate taxes paid due to various deductions and credits. Designed as a safeguard to ensure that corporations with over $1 billion in average financial-statement profits over three years pay a minimum tax rate, the CAMT has shown limitations and complexities in practice. Despite its intention to standardize corporate tax contributions, companies can still leverage specific tax breaks, leading to potentially lower effective tax rates. The Biden administration seeks to expand and increase the CAMT to raise significant revenue, though the absence of detailed guidelines has led to challenges in its application and varying impacts across industries. The CAMT's introduction has stirred discussions around its effectiveness, with companies navigating the new tax landscape through estimation and future tax offset opportunities, highlighting the nuanced outcomes of tax policy adjustments.

Bipartisan Business Tax Bill Stalls in the Senate

A bipartisan bill aimed at expanding the child tax credit and reinstating various business tax breaks has faced a stall in the Senate, jeopardizing its passage. Initially receiving strong bipartisan support in the House, the bill's progress has been hindered by opposition from some Republicans who are concerned about reinstating the child tax credit. The $78 billion tax package, intended to be in effect through 2025, proposes enhancements to the child tax credit and the restoration of tax deductions related to business research, capital expenses, and interest, alongside other provisions beneficial to small businesses. However, the financing of this bill through the restriction of the employee retention tax credit, a measure criticized for its susceptibility to fraud, has sparked debate in the Senate.  At Harmony, we worked to get the ERTC credits for our clients early as many later claims remain in limbo.