Same-Sex Couples And The Marriage Penalty

By Michael Einheuser

The June 2013 U.S. Supreme Court's ruling struck down one section of the Defense of Marriage Act (DOMA), but upheld another section creating a legal quandary for some couples. States are no longer prohibited from recognizing same-sex marriage. But states are also not required to recognize same-sex marriages of other states or governmental jurisdictions. The legal consequences of same-sex marriage varies depending on the state where a couple celebrated their marriage and where they reside.

On Aug. 29, 2013 the U.S. Department of Treasury and the Internal Revenue Service issued Revenue Ruling 2013-17 regarding same-sex marriages that pronounced how it will apply its law to certain facts.

The IRS applies the "state of celebration" standard to define valid marriages. Specifically the ruling states:

"For Federal Tax purposes, the term 'spouse,' 'husband and wife,''husband,' and 'wife' include an individual married to a person of the same sex if the individuals are lawfully married under state law, and the term 'marriage' includes such a marriage between individuals of the same sex."

Same-sex Michigan couples with marriages valid in other states must file their federal tax returns as married filing jointly or married filing separately. This includes the 300-plus same-sex couples married in Michigan on Mar. 22 before the Court of Appeals stayed Judge Bernard Friedman's ruling in the DeBoer case.

In the literature on marriage equity, some have sounded the cautionary sentiments of "be careful what you wish for." The income tax marriage penalty is one reason to be cautious.

The marriage penalty refers to the fact that the income tax liability of married couples in certain situations is greater than it would be if they filed separate single returns. The penalty is usually greatest when both spouses have good incomes.

Tax rates are set on a graduated scale. The greater your income, the higher your marginal tax rate. The IRS engages in the fiction of income splitting for married couples. The total incomes of both are attributed to each equally. If you marry someone in a higher bracket than yourself, you will likely incur a marriage penalty and your spouse is likely to incur a marriage bonus. His income brings you into a higher tax bracket and yours brings him into a lower tax bracket.

The married couple that most benefits from the concept of income splitting are one-income couples like Ward and June Cleaver. Regardless of how much Ward earns, half of it is attributed to June, lowering their marginal tax bracket. But income splitting has the opposite effect if June goes out and gets a job. Anything she earns provides additional income that is either taxed at their highest marginal rate or worse, pushes them into an even higher tax bracket.

Consider Michelle and Annie. Michelle is a business executive who earns $240,000 and Annie is an artist with an income of $13,000. As a single tax payer, Michelle's tax liability is $59,709. She falls in the 33 percent marginal tax rate. Annie pays $286 because she is in lowest tax bracket - 10 percent. The total amount of taxes for both of them is $59,995.

When they file as a joint married couple Michelle benefits from Annie's low tax bracket. Their joint tax is $52,696 creating a marriage bonus of $7,299.

But if we look at Terry, a chiropractor earning $225,000 per year, and his partner Nick, an attorney who earns $190,000, the picture is very different. As individuals, Terry's tax is $54,759 and Nick's is $43,534 for total taxes of $98,293. When they file as a married couple their tax liability goes up to $108,450 creating a marriage penalty of $10,157.

Another component of the marriage penalty is the decision to itemize deductions or to take the standard deduction. One can deduct charitable contributions, state and local taxes and real estate interest on a personal residence from one's income. In 2013, the standard deduction was $6,100. If one partner has deductible expenses of $10,000, she will itemize and get a deduction for the full amount. If the second partner has no deductible expenses, she will take the standard deduction of $6,100. When they get married, they must either take the standard deduction or itemize. They will choose to either itemize the $10,000 or each take the standard deduction ($6,100 x 2 = $12,200) but will lose the combined deduction of $16,100 they had when they were single.

Anyone curious about a potential marriage bonus or penalty can find some very easy to use marriage penalty calculators on the web.

Next time - estate planning issues for same-sex couples.

Michael Einheuser is an estate and retirement planning attorney in Bingham Farms who specializes in helping families preserve their wealth, reduce potential taxes and eliminate the uncertainties of probate.
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