Judging by many of the questions and discussions recently on the Motley Fool's Tax Strategies Discussion Board, many of you are interested in the so-called "marriage penalty." Some of you out there, especially the confirmed single type, may giggle and think that marriage itself is all the penalty you could stand. While that may be true for you, many other folks, blissfully and eternally in love, have found that the wonderful state of matrimony has hiked their tax bill. Unexpectedly. And, some may say, unnecessarily. It really is a painful realization, and many times that realization doesn't hit home until the first time the "joint" tax return is prepared. So it might be a good time to take a look at the marriage penalty, what it really means, and how it works.

The Penalty: More Tax

Many people believe that the "married-joint" filing status allows them to pay less in taxes than a "single" filing status. This is often far from the truth. Many also believe that the "married-joint" tax rates and exemptions are simply double that of the "single" rates and exemptions. This is also not true. The marriage penalty generally kicks in whenever both spouses work and they have to pay at a higher "joint" tax rate on the same total income than they would pay if each were single. This usually happens where both spouses have relatively equal incomes.

Take the case of Bill and Mary. Let's assume a single filing status for each of them with wages of $32,500 each in 1999. Let's also assume that they had no other income (such as interest, dividends, and capital gains) and did not itemize their deductions. For 1999, each of them would have a tax liability of $3,821. That means that for the two of them, each using the single filing status, their total tax liability would amount to $7,642.

But now let's see what happens to Bill and Mary if they had exactly the same income, but were required to file a "married-joint" tax return for 1999. If you run the numbers you'll find that their JOINT tax liability would be $9,055. That's right. Bill and Mary get the unique pleasure of paying $1,431 in additional taxes (almost 20% more) simply for the privilege of being married. No other reason.

Ouch! Now that's a penalty. Just for being married. See how the "marriage penalty" handle came about?

But… WHY?

The standard deduction for the joint return is $7,200 — less than half of the standard deduction for two single standard deductions ($4,300). But the main reason for the penalty is that the joint return filers will pay tax at a 28% tax rate on much of their income, while the singles both pay at a top rate of only 15%.

How is that possible? Well, all you have to do is look at the tax tables. If you look at the single table, you see that the 15% rate bracket tops out at a taxable income of $25,750. Common sense might tell you that the joint 15% bracket would then top out at $51,500. But as I have pointed out many times in the past, taxes and common sense often don't go hand in hand. The actual top end of the 15% rate for a joint return is only $43,050. This is substantially less than twice the single top end amount, which is why the joint return will pay tax at the 28% rate while the two single returns will never get above the 15% rate.

And it gets worse. At the high end of the scale, if each spouse had taxable income of, say, $137,000 (total of $274,000), the couple would pay $8,471 more tax than if each were single.

But the tax bracket issues aren't the only part of the marriage penalty puzzle. There are others, which may not apply to everybody every year, but will still mean more taxes to be paid when they do hit. Here's a list of some of the more common ones:

Quicker loss of itemized deductions: A married couple starts to lose some of their itemized deductions when their total combined adjusted gross income for 1999 exceeds $126,600. If single, each could earn $126,600 (or a total of $253,200) before losing any itemized deductions.

Quicker loss of personal exemptions: For 1999, a married couple starts to lose their personal exemptions at combined adjusted gross income of $189,950. If single, each could have adjusted gross income of $126,600 (for a total of $253,200).

Lower capital loss deduction: A married couple can deduct excess capital losses up to $3,000 total. The same two persons, if single, could deduct a total of $6,000 ($3,000 each).

Reduced passive activity loss deduction for active rental real estate owner: A married couple who actively participate in renting out real property can deduct up to $25,000 of loss from the activity if their modified adjusted gross income is $100,000 or less. If single, each could get a $25,000 deduction (up to $50,000 total) and each could earn $100,000 ($200,000 total).

Roth IRA Conversions: If you want to convert your traditional IRA to a Roth IRA, your modified adjusted gross income must be less than $100,000. This is true for both the single and joint filing status. So two single people with modified AGIs of $90,000 could both make a Roth IRA conversion. If those same two people were married, no conversion would be available because their combined modified AGI would be greater than the $100,000 limitation.

Earned Income Credit: As with IRA conversions, the income phaseout limitations are the same for single folks as they are for a married couple.

I'd give you a few more examples, but I'm afraid that some of you married folks out might begin to feel sick. And we wouldn't want that. It's likely enough to make you ill by just pointing out that the above list is not all inclusive. There ARE others. But you can see how so many quirks in the law can penalize the married taxpayer.

On the other hand, tax can be somewhat lower for some married people filing jointly than if they were single where there is a wide discrepancy in their earnings. And couples with only one spouse working and earning might even realize a marriage "bonus" rather than a penalty. There's just no universal rule.

A Call to Arms

Many point to the marriage penalty as a need for a fairer and more logical tax code. A number of folks in the House and Senate have attempted to address this issue and correct it…obviously without success. The marriage penalty issue has become, sadly, nothing more than a political football. But this is not an issue that is completely lost on your federal representatives. If you believe that the marriage penalty is just a way for Uncle Sammy to reach deeper into your pockets, you might want to express your feelings directly to Congress. We both know that the Congress isn't too keen about doing away with the marriage penalty and watching billions of dollars leave the federal coffers, so you can expect a lot of foot dragging and haggling over the issue. It's a thorny problem, no question about it. But difficult problems shouldn't simply be ignored in the hopes that they will go away.

Finally, a few folks will attempt to overcome the marriage penalty by filing "married-separate." In many cases, this is not the answer. There are many complications to this filing status that are not immediately apparent on first blush. Next week we'll take a closer look at the "married-separate" filing status and some of the benefits and pitfalls that are attached to it.

If you like the way Roy Lewis simplifies confusing tax issues, check out his just-published book, The Motley Fool's Investment Tax Guide 2000: Smart Tax Strategies for Investors. This handy 360+ page guide covers just about every tax aspect of a typical Fool's life: investing, marriage, children, education, homes, home offices, retirement accounts, medical expenses, and much more.)

May 19, 2000

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