By David Rae
Originally published on Advocate.com February 24 2014 5:17 AM ET
Many gay couples have been rushing to the altar due to state marriage bans being struck down across the country, and truly, congratulations are in order. While some may not notice much of a difference when doing their taxes, other couples at the top and bottom of the financial spectrum may get hit with what heterosexual couples have long called, the marriage penalty.
For the first time, when filing their 2013 taxes, gay couples will be able to check the “married” box and will be recognized as legally married by the IRS. Before you pop the expensive champagne, you may want to review your tax burden for 2013 and going forward with 2014. Same-sex married couples now get all the benefits and penalties associated with being legally married at the federal level. (Not all states recognize all marriages yet, so filing of state taxes for gay couples will vary from state to state.)
The discriminatory practices of the Defense of Marriage Act kept many gay couples from experiencing the marriage penalty. However, this tax season will be the first time couples will be allowed to file as married on their federal forms. Some couples who married last year have been together for decades, and have been filing their taxes separately for all of that time. These couples may be in for a bit of a shock when filing with their new status this year. The marriage penalty generally has the biggest effects on couples at the very bottom and very top of the scale, especially couples with disparate incomes.
The U.S. has a progressive tax-rate structure. Put simply, you will pay a higher income tax rate on the last dollar you earn than the first. This is true for everyone. For married couples the marriage penalty refers to the higher income tax liability a married couple would face compared to two individuals with exactly the same income. Couples may end up owing more taxes when filing jointly compared to if they had filed separately.
Within each couple there may be an income tax winner and loser if incomes are unequal. For example if a couple has a high earner and a low earner, one spouse will pay more taxes than if the individual filed separately. The other would essentially get a marriage bonus and end up owing a lower amount of taxes than if the individual was single.
The simplest way to think of this is to picture one income being stacked on top of the other. But the rub is the tax brackets for married couples don’t reflect a doubling of brackets for individuals. Essentially income will hit higher tax brackets (meaning higher taxes due) for two married people, versus the same income amount for two single people
Married couples may also get penalized on the tax deduction side as well. A married couple that files jointly is forced to use the same method of deduction (standard deduction, or itemized deduction). When one spouse itemizes their deductions and the other has limited deductions you may be left with less of a tax benefit than the standard deduction would have offered.
Many couples in the past haven’t had to worry about tax deduction phase outs, but with new filing statuses, more couples will start to hit the income thresholds that start to phase out some of the most popular deductions. These deductions include the mortgage deduction and investing expenses.
Beyond basic income tax penalties, newly combined incomes may trigger the new Medicare Surtax on combined income above $250,000. This surtax of 0.9 percent can add up quickly and couples in this income range should also be aware of a new tax on investment income as well.
For couples where one spouse is receiving government aid, or even financial aid for school, a combined income after marriage could reduce or eliminate those benefits.
Additionally, Obamacare has added a new layer of hurt to the marriage penalty. The thresholds for subsidies are more beneficial for individuals versus married couples. A married couple would have to earn less than $62,040 to receive a subsidy, while a nonmarried couple could make up to $91,920 total and still be potentially eligible to receive a financial break.
Federal recognition of all marriages whether they are gay or straight, is a huge plus for the LGBT community and in my opinion, America as a whole. This is a time to celebrate and be proactive by learning the reality of your tax filing status. This may lead you to revisiting your financial plan and looking for a way to better manage your tax brackets and tax burdens now and in retirement.
I’m getting married to my fiancé this year and while we’re excited, we’re not looking forward to getting slapped by the marriage penalty. Hopefully our planning will help ease the sting. Consult with your financial professionals to see how the marriage penalty may affect you and your current or future spouse.
And, incidentally, if you have been married at the state level for several years, you may be able refile up to three years of prior-year tax returns. This may entitle some of you to a refund and should you owe more, you won’t be required to amend your old returns.
DAVID RAE CFP®, specializes in holistic financial planning for the LGBT community. He lives in Los Angeles with his fiancé and two Chihuahuas. Follow him onFacebook on Twitter at @davidraecfp or via his website, DavidRaeFP.com.
Securities and advisory services offered through National Planning Corporation, member FINRA and SIPC, a Registered Investment Advisor. Trilogy and NPC are separate and unrelated entities. NPC does not provide tax advice. This information is general in nature and should not be construed as tax advice.