There are many financial perks that come with being married. Filing taxes generally isn’t one of them. If a complex, arcane tax code leaves singles confused and frustrated, try doubling the confusion associated with credits, deductions and income.
For all the rules of thumb, there are myriad exceptions, which your accountant should help you navigate. Not sure if you’re getting sound advice? Read on, because these experts give a frank account of tax planning for married couples — the good, the bad, and the ugly.
Some couples receive tax bonuses, and some get tax penalties. Trying to game the system is generally a futile exercise, experts say. “The marriage penalty applies when a married taxpayer filing a joint return ends up paying more taxes than two individuals would earning the same amount of income,” says tax research analyst Lindsey Buchholz of H&R Block.
For 2012, the marriage penalty is lower than prior years because of tax relief included in the Bush-era tax cuts. Without this provision being extended at year's end, the standard deduction will decrease in 2013, dropping to $9,900 from $11,900, according to H&R Block.
The marriage tax relief is among the provisions set to expire Jan. 2 that, combined with automatic budget cuts, could trigger what is called the "fiscal cliff" unless Congress intervenes. (Read More: The Fiscal Cliff Will Cause a Recession, CBO Says)
At the very least, you should know where you stand. The Tax Policy Center created a calculator to help you figure out whether you pay a penalty or get a bonus.
According to this tool, couples with roughly similar income would start to face a marriage penalty if they each earn more than $80,000 per year, assuming a simple 10 percent state and local tax without itemized deductions. Though initially small, this penalty grows with income and hits high-earning couples disproportionately harder.
“I’m annoyed that our taxes will go up substantially,” says newlywed Kerri Damm of New York, a product manager for an e-commerce website. “It’s like we’re being penalized by Uncle Sam for having gotten married, because we are now surpassing an income limitation that is archaic for what is considered middle class.”
Regardless of where you fall on the married tax rate spectrum, you’ll need to know some rules to soften the blow.
Filing Separately Versus Jointly
When you get married, you can no longer file as a single individual. Instead, you must choose between the filing statuses of married filing jointly, or married filing separately.
“Ninety-nine percent of couples are better off filing jointly. It rarely makes sense for marrieds to file separately,” says Bob Meighan, vice president at Turbo Tax. (Read More: Most Widely Held Stocks You May Not Know You Own)
Accountants say filing jointly delivers better tax results because some tax benefits are legally prohibited if you file separately. The most common of these benefits are:
• American Opportunity Tax Credit – for education expenses
• Earned Income Tax Credit – available to lower-income individuals
• Child and Dependent Care Credit – to offset childcare costs so parents can work
• Student Loan Interest Deduction – for interest paid on student loans
But there's a catch...
But there’s a catch. These tax benefits are subject to income tax thresholds and may be completely eliminated for those earning above a certain income threshold. If this situation applies to you, consider the main reasons couples choose to file separately, according to H&R Block:
Delinquent Debt: If one spouse has past-due child support or delinquent student loans, the refund on a joint return is held back by the IRS and applied to the debt. If a couple filed separately in this case, the non-liable spouse will receive their refund.
Income Gap: If there's a large gap in income between spouses and the spouse with the lower income has a large number of deductions, filing separately can be a good strategy. The most common example is medical deductions, which must reach a threshold of 7.5 percent of adjusted gross income before they are deducted. The threshold is more easily reached if incomes are reported separately rather than jointly.
Once the filing choice is made, marrieds can look for ways to reduce their taxable income, and thus reduce their tax rate. (Read More: What You Should Know About Your Spouse's Money)
Reducing Your Taxable Income
If your tax pro hasn’t walked you through the basics, there’s no time like the present.
The most common way to reduce your taxable income is to invest in retirement accounts like 401(k)s and IRAs. “It’s a good idea to contribute as much as you can, and get your employer to match your contribution — effectively earning you twice as much in savings,” said Buchholzof H&R Block. That said, you will pay taxes on this income when you withdraw these funds in retirement. But until then, income spent on them is not taxable and returns grow tax-free.
If you’re homeowners, you can deduct mortgage interest and property taxes. Since the First-Time Home Buyer Credit expired in 2010, these deductions are the main incentives for homeownership.
If you’re business owners, you can deduct many expenses — the major ones being health-care and auto insurance. “It makes sense to write off both medical insurance premiums and auto insurance through your business. And if you’re working from a home office, home insurance and property taxes are also deductible,” says Turbo Tax’s Meighan.
For organizational purposes, Meighan advises separate checking accounts and credit cards in order to distinguish personal expenses from business expenses.
Higher education is another tax-friendly cost. By investing in college savings plans known as 529 plans operated by states, you'll be reducing your taxable income. These investment funds grow tax-deferred — and as long as they are used to pay for the beneficiary's college costs, the money is distributed tax-free.
And for marrieds with means, ‘tis the season for giving. Each year, married couples can give up to $26,000 in gifts to any individual without paying taxes, according to H&R Block. Parents might consider this as a smart way to pass on wealth while they’re alive, instead of putting it in their will.
Common Credits Add Up
In tax parlance, credits are the Holy Grail. “A credit means that dollar for dollar, your tax liability is reduced. For example, if your refund is $1,000 at the end of the year, and you’ve qualified for a $2,000 credit, you go home with $3,000,” says Meighan.
As deductions simply reduce your taxable income, credits are clearly more valuable. While income thresholds tend to be low in order to be eligible for credits, here are a few to consider.
Education and children are common sources of credit eligibility. If a spouse decides to go back to school, there is a sizable credit available in the American Opportunity Credit, which is worth up to $2,500, and which should be combined with tuition and fees deductions. The child tax credit, and the child and dependent care credit are also available to parents. Your accountant will know if you are eligible.