The Marriage Penalty
Using the spreadsheet supplied with this website, here is an example of the marginal
tax hump for a single individual with a $30,000 Social Security benefit. This
individual can also have an extra $34,567 of pre-hump taxable income,
resulting in a 2018 after
Federal tax net income of $60,115, a 6.9% overall tax rate. Their next $9,138 will
be taxed at 40.7%. If two single individuals were living together as domestic
partners, their combined income and taxes would merely be twice the size of each
individual. Their pre-tax hump net income would be $120,230.
The second image representing the marginal tax hump faced by the same couple
if they decided to get married and file a joint return.
Note how the dotted green Taxable SS line starts well before the start of their
taxation. The SS taxation of each individual in the first graph starts at a Basis
Income level of $25,000, a combined $50,000 for the domestic partners, while taxation
for the married couple starts at only $32,000. This earlier start of SS taxation
results in a pre-hump net income of only $110,491 for the married couple, a
Marriage Penalty of almost $10,000.
What Causes The Marriage Penalty?
The primary cause of the Marriage Penalty is the starting positions for the taxability
of your Social Security benefits. The calculation of the “basis” for this taxation
is the same, basically half of your Social Security benefits plus your other taxable
income. 50% taxability starts when the basis exceeds $25,000 for a single individual,
which would double to $50,000 for domestic partners. But the 50% taxability
starts at only $32,000 for a married couple, and 85% taxability starts at $44,000,
which is still $6,000 less than the $50,000 combined start of the 50% taxability
level for the domestic partners.
At the $50,000 taxable basis level $11,100 of the married couple’s Social Security
is being taxed while none of the domestic partner’s benefits are taxable. Over the
next $18,000 of income another $15,300 of the married couple’s benefits become taxable
while only $9,000 of the domestic partner’s benefits become taxable. At this point
the marriage penalty reaches its maximum where an additional $17,400 of the married
couple’s benefits are being taxed.
This $17,400 taxable penalty continues for variable amount of income based on the
size of the Social Security benefits levels. If the total benefit levels of each
couple are identical, the domestic couple will continue to increase their taxable
benefits for another $20,471.
So, basically, the married couple’s Social Security benefits are taxed at lower
income levels. Their potential tax free income is $7,427 less, and their personal tax
hump starts $9,731 before that of the domestic partners. Since this results in them
saving less tax dollars at the lower income levels, the size of their personal hump
is also smaller because they have less to give back to the IRS.
At higher income levels, when everyone is paying their full hump taxes, everything
basically evens out because at that point everyone is paying taxes on the same 85% of
their Social Security Benefits. Married couples just pay it earlier. The only penalty
that remains is that the additional over 65 standard deduction is only $1,300 for
married individuals and $1,600 when you are single.
The Widow(er) Penalty
If you did not plan your inheritance properly, your surviving spouse could have
the same income as you did as a married couple while being faced with higher tax rates
because they will have to file the same income levels as a single individual instead
of a married couple.
In this example we see a married couple with $25,000 and $30,000 Social Security
benefits plus additional taxable income of $45,000 from pensions, annuities, IRA
withdrawals, etc. Their total annual married income is $100,000 and the top graph
shows that their income level is more than $15,000 below their personal 40.7% Marginal
Tax Hump. Their federal taxes will be $5,452.
When one of them passes away, the survivor will lose the $25,000 SSB and keep the
larger SSB. Assuming that all of their pensions, annuities and other income continues
for the survivor, the additional income will remain at $45,000. The Widow’s annual
income will drop to $75,000 and the lower graph shows that her income level will
be higher than the top end of her personal 40.7% tax hump created as a single individual
vs. a married couple. Her federal taxes will be $8,454!
The Widow is not only losing the $25,000 SSB, but also has to pay an additional
$3,002 in taxes!
Can this be avoided?
One of the things they might have considered would be to calculate their taxes in
December each year, then do a Roth Conversion that will maximize their 22.2% Marginal
Federal Tax Bracket. If the widow could reduce her other taxable income by $11,000
each year she would save $4,130 in taxes. This could be done with an annual withdraw
from a tax free Roth account of $6,870 ($11,000 minus $4,130).
If your inheritance to each other passes as taxable income the immediate and lifelong
tax penalties could be substantial. Even if the taxes are not immediate as your
individual IRA is combined, sort of tax free now, with your spouses IRA, the larger
combined IRA will have a much larger MRD, Minimum Required Distribution, for the
remainder of the surviving spouses lifetime.