Tax Planning for Newlyweds
by Maria Blair, EA
The wedding invitations are sent out. The reception hall is booked. Now, let’s do some tax planning. Really?
A taxpayer’s marital status for the entire year is determined as of December 31st. If a taxpayer is married on December 31st, he or she is considered married for the entire year. This can present some tax planning challenges for newlyweds, particularly in the area of Federal tax withholding. The Federal tax system is based on graduated tax rates. As income increases, a taxpayer is bumped into higher tax brackets. Once married, the income of the married partners is combined, because they are considered to be one economic unit. As a result of the combined incomes, the married couple will have higher overall income. Because of the December 31st rule mentioned above, even if the partners are married on December 30th, they are considered as married for the entire year, and the income is taxed on a combined basis.
Will this result in higher taxes and a marriage penalty or, conversely, a marriage bonus with lower overall taxes? It depends primarily on the spouse’s income. The more unequal the income is between spouses, the more likely that combining the incomes on a joint return will pull some of the higher-earners income into a lower tax bracket.
The lowest tax brackets (10% and 15%) usually do not cause tax problems. The bracket range for married couples is exactly double the single range at these rates. Once combined income for a new couple is over $75,000, however, some serious planning on the amount of taxes to be withheld needs to be done. When combined incomes exceed $75,000, the tax bracket for those who are married and filing jointly accelerate more quickly than the single tax brackets, so combining incomes leads to higher tax brackets As an example of how under-withholding in this situation can occur, consider this example:
In 2015 a single taxpayer can earn $90,750 of taxable income before the 28% tax bracket is reached. Assume a single taxpayer making $90,750 married another single taxpayer making $90,750. One might anticipate that the 28% rate for married taxpayers would not begin until $181,500 of taxable income was reached ($90,750 + $90,750 = $181,500). For married taxpayers filing jointly, however, the 28% tax bracket begins at $151,200. Bottom line: Combining significant incomes will result in additional taxes.
Because a marriage at any time during the year requires that the spouses combine all of their income for the year for tax purposes, a couple planning on getting married should sit down as early as possible in the wedding year and adjust the withholding amounts from their paychecks. Basically, the newlywed couple will need to project their tax liability for the year. The IRS provides Publication 919 How Do I Adjust my Withholdings? to help with these calculations. Also helpful is the two-earner worksheet on page 2 of the W-4 form. The partner with the higher wages usually claims married with one exemption, while the other partner withholds at the higher single rate. The goal here is to get the withholding as close as possible to cover the married tax liability. Unfortunately, most married couples do not consider the tax impact of combining incomes and end up under-withholding the taxes from their wages, which can result in a large tax bill come April 15th.
To make things a bit more complicated, a married couple can choose to file married jointly or as married filing separately. Generally speaking, it is most advantageous for couples to file married jointly; the benefits of filing married separate exist in only a few unique circumstances, say when there is a huge income disparity or when one of the spouses has very large medical deductible expenses. The only sure-fire way to tell which filing status will produce the best results, however, is to run projections for both.
Couples that live in different states prior to getting married, or who will continue to work in different states after they get married, also need to do additional planning. The couple will likely need to file two separate state tax returns for the year of marriage in most cases. Complications and the need for additional tax planning also arise when couples live in states that are community property states (all marital property is divided equally between spouses in a community property state). There are nine community property states in the United States, including Arizona, California, Texas, and Wisconsin.
There are additional tax planning concerns for newlyweds. We highlight some of the more important ones here:
1. If one of the partners is changing their name, that partner must notify the Social Security Administration by filing form SS-5 along with a certified copy of the marriage certificate. This step should be taken as soon as possible, as this process can take several weeks, and the names and social security numbers on a tax return must match the records at Social Security exactly.
2. Couples should try to coordinate fringe benefits at each workplace. Pick the best medical plan that works for you, and avoid unnecessarily doubling up on coverages.
3. A couple should maximize their retirement accounts. If there is a limited budget for retirement savings, then the couple should check which employer has the better plan and invest their money in that plan. If at all possible, each partner should try to contribute enough to the employer’s plan to receive any matching funds. This is free money, which will be wasted if no retirement savings are done.
These are complicated calculations, to be sure. In all but the simplest of cases, a newlywed couple should consider turning to a professional to help sort out the withholding and file the income tax returns. We always recommend planning ahead and working to avoid surprises. Why add any unnecessary stress to a marriage?