Although looked upon primarily as a way for governments to raise revenue, taxes have also long been used by federal, state, and local governments to incentivize or discourage certain behavior. Sin taxes on tobacco, alcohol, and gambling are seen as a way to discourage these practices while raising revenue to combat the harm the activities do to society. Similarly, a federal corporate payroll deduction incentivizes businesses to spend more money on wages, which in turn boosts the spending power of the American consumer. Although many incentives built into tax codes are intentional, some are not, but do nonetheless incentivize and discourage certain behavior. The marriage penalty/bonus is one such unintended consequence that can motivate individuals to act differently to avoid large tax liabilities.
An Unintentionally Backwards Provision
The marriage penalty/bonus is the increase or decrease in a married couple’s individual income tax liability as a result of getting married and filing a joint return. This has been a part of our federal tax code since at least 1918, when the Revenue Act of 1918 introduced the ability for married individuals to file a joint return. Generally, marriage acts as a penalty (an increase in tax liability) for married couples who fall on the higher end of the earnings spectrum and both earn roughly the same income. However, a bonus (a decrease in tax liability) typically applies to married couples when one spouse earns a majority of the income, while the other spouse earns little or none at all. The difference is due to the different brackets that apply to married couples as opposed to single tax payers. Because married filing jointly brackets are not exactly double the single filing brackets, married couples may find themselves in a higher tax bracket as a result.
The practical result has led to considerable controversy, as the discrepancy appears to incentivize an ideal in which one spouse stays home and another is the primary breadwinner. However, the marriage penalty is the result of three competing, but ultimately irreconcilable, income tax policies: equal treatment of married couples; marriage neutrality; and progressive taxation. All three cannot exist at the same time, and generally policy makers decided to opt for progressivity and equal treatment between married couples, resulting in the code’s marriage penalty, as a Congressional Budget Office report explains.
Minnesota, the Lone Warrior
Minnesota leads the nation with its attempt to study and address the problem. Minnesota’s joint filers’ tax brackets are not twice that of a single filer’s, leading to the possibility of a penalty/bonus. In a recently released House research Department information brief, two examples are offered to show the brackets’ practical effect:
An example of a penalty:
“H and W each earn $40,000 and claim the standard deduction. If they can file as singles, each will have Minnesota tax liability of $1,655 or a combined tax of $3,310 for tax year 2017. If H and W marry and file a joint return, their combined tax increases to $3,543, resulting in a marriage penalty of $232.”
And an example of a bonus:
“W earns $80,000 and claims the standard deduction. H has no income and no tax. W’s tax as a single filer would be $4,475 for tax year 2017. Marriage to H will reduce the tax to $3,543, resulting in a marriage bonus of $932.”
Minnesota is the first state in the nation to offer an income tax credit to offset the marriage penalty shown by the example above. The credit is equal to the difference between a couple’s Minnesota tax liability on earned income and the Minnesota tax liability they would have paid had their earned income been taxed according to the single tax brackets. As a result, the credit does not affect marriage bonuses, nor does it affect penalties that are the result of federal income tax provisions.
Federal Tax Reform Marriage Penalty/Bonus Solution?
Whether intentional or not, federal lawmakers have included brackets which would eliminate the marriage penalty in both the House and Senate versions of the bill. Nothing has been passed into law, however, the brackets themselves remain one of the less controversial pieces of the plan. Should the brackets pass unchanged, it would signal an end to the income tax marriage penalty at the federal level. It would then fall upon states to decide whether to follow the federal government’s lead on this issue.
It is important to note, however, that marriage penalties and bonuses can be found hidden in the various deductions and credits federal and state governments offer. For example, penalties/bonuses can be found in the differences between how incentives are calculated for married couples versus individuals, or in income phase-outs amounts. Although many itemized deductions are repealed in the latest version of federal tax legislation, many states will decide for themselves whether to keep them and other incentives, including the Child Tax Credit and the Earned Income Tax Credit. The need for legislation to respond to federal tax law changes may represent an opportunity to eliminate hidden marriage penalties and bonuses, but time will tell whether lawmakers take advantage.
Many taxpayers who are unfamiliar with the tax code may be surprised to see an increase in their tax liability after marriage. For such a momentous decision as whom to marry, a marriage penalty of a few hundred dollars may seem trivial. It is however important that tax professionals and their clients be aware of tax liability increases, changing eligibility, and phase-out of incentives that may impact tax planning throughout the course of their happily-ever-after tale.
Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: One perspective on this issue is that dual earners have a higher potential combined income than single earner couples, because both spouses have careers through which they can earn bonuses, raises, and promotions. With that in mind, should lawmakers seek to eliminate the marriage penalty, or further strengthen it?
To learn more about Congress’s tax proposals, download Bloomberg Tax’s Roadmap to House and Senate Tax Reform Plans, available here.
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