You’ve heard the saying, “two can live cheaper than one.” Well, two people who are married can also pay a whole lot less in income tax. The reason is, that the tax code is structured to give married people a break, but this may not be plainly apparent. For the purpose of this article, lets consider a real example of two people, Jane and John Doe. We will consider the implication of their filing returns as single people and as married tax payers for the same year. Lets say that they each make $25,000 per year and we will use the tax rate schedules of tax year 2009 for demonstration purposes.
As single filers, Jane and John are entitled to a personal exemption of $3,650 each, and assuming they will use the standard deduction (not itemizing deductions) their deduction will be $5,700 each. The sum total of their exemption and standard deduction will be $9,350 each. Buy subtracting this from each persons gross income, we end up with a taxable income of $15,650. The tax on this amount would be $1,926, so Jane and John would pay combined taxes of $3,852.
Now lets look at the same scenario, but in this case, Jane and John become married on or before the last day of the year. Now their filing status is Married filing jointly. They still get the $3,650 personal exemption for each of them which combined is $7,300. They also get a standard deduction of $11,400 which is double what they each were entitled to on a single basis. Their total deductions are therefore $18,700 which when subtracted from their combined income of $50,000 leaves a taxable income of $31,300. Their tax on this amount would be $4,274 . In this case, being married cost Jane and John an extra $422 in income tax and would certainly not be an advantage.
Fortunately, as a married couple, Jane and John have the option of using the filing status of “Married filing separate returns,” in which case their combined tax would be $3,852, or the same amount as if they filed singly. A good tax preparer will always calculate the return both ways and then advise the client as to the best scenario for their situation. If you do your own tax return, figuring it both ways is up to you. This situation is often referred to as the marriage penalty.
But the forgoing scenario is pretty simple and there are a lot of other advantages a married couple can take advantage of. For instance, as single people Jane and John’s independent incomes of $25,000 per year would not be enough to qualify for a home lone. But their combined income of $50,000 might be enough to qualify for a lone on a small house. Let’s say that as single people they were each paying rent of $1,000 per month. Married, they could make a house payment of $2,500 per month; without too much difficulty. This would translate into mortgage interest payments of about 23,000 per year in the early years of a lone.
It would now make sense for Jane and John to itemize deductions on their return instead of taking the standard deduction of 11,400. In addition to their mortgage interest, Jane and John could also write off (deduct from taxable income) sales taxes, state and local income taxes, property taxes, auto license fees, charitable contributions, medical and dental expenses in excess of 7.5% of their Adjusted Gross Income(AGI) and other miscellaneous deductions like tax preparation fees and employee expenses. For purposes of this discussion, let’s assume that Jane and Johns Itemized deductions totaled $27,650. Combined with their personal exemptions of $7,300, this would give Jane and John a total of $34,950 of deductions resulting in a taxable income of $15,050. The tax on this amount would be $1,836. All of a sudden, being married has a very big tax advantage, but it doesn’t stop there.
As single people and assuming they met other qualifications, Jane and John could each contribute $5000 to an IRA account. As a married couple Jane and John making the maximum Traditional IRA contribution, would have an additional $10,000 of write off against their taxable income. Taking this into account, Jane and John’s taxable income could be reduced to $5,050 with tax of $503. Essentially, that is like having the government contribute $1,333 into your IRA for you.
While the forgoing tax implications with respect to marital status are pretty significant, there are a whole lot more less obvious implications married people might want to know about. Whether you do the research on your own or pay a tax professional to provide preparation and consulting services, a little advanced planning can turn into big tax savings on April 15th.