David Helverson, CRPC, is a Financial Advisor who holds the Accredited Domestic Partnership AdvisorSM Designation with Wells Fargo Advisors, LLC, in Chicago. He addresses the financial challenges that same-gender partners face. Reach David at firstname.lastname@example.org and https://home.wellsfargoadvisors.com/david.a.helverson1.
According to the latest information from FreedomtoMarry.org, same-gender couples now have the freedom to marry in 32 states plus Washington, D.C. Moreover, recent federal appellate- and lower-court rulings in a number of additional states favor the freedom to marry. At the time of this writing, nearly 59 percent of the U.S. population lives in a state that is currently issuing marriage licenses with a strong likelihood that the percentage could increase.
Whether you are in a same-gender couple or an opposite-gender couple, for many newlyweds, year-end tax planning and preparation may be significantly different than in years past. In this article, we’ll examine some of the ways that marital status can impact your taxes and investment plans.
A primary consideration is filing status: All legally married couples, same or opposite gender, must file federal income taxes as married persons. Though filing status seems self-evident, married couples can choose to file jointly or separately. However, filing separate returns as a married couple is not the same as filing returns as an unmarried individual. In comparing rates for individuals and couples with taxable income in the 10 percent, 15 percent and 25 percent tax brackets, there is no difference in the amount of tax owed as the rates for joint income are simply twice the individual rates. However, when joint taxable income reaches the 28 percent, 33 percent, 35 percent and 39.6 percent brackets, couples filing jointly will pay more than if they were filing as unmarried individuals. This so-called “marriage penalty” may lead some couples to investigate filing separately, but the tax burden is often higher than it would be in a joint filing. In 2009, the most recent year for which we have data, the IRS reports that only 4.3 percent of married couples filed separately. The decision to file jointly or separately requires careful consideration of income, deductions, child support, healthcare costs and other factors. It is a good idea for married couples to sort out these issues with a tax professional to determine their optimal filing status.
If a same-gender married couple resides in a state that does NOT recognize marriage equality, they will be required to file their federal returns jointly or married filing separately as previously described, but will also have to file individual state tax returns as if they were unmarried singles. Because state tax rates are based upon income reported on the federal return, each spouse will need to file a “dummy” federal individual tax return to determine the individual taxable income needed to determine the respective state tax. Consequently, preparation time and costs may be higher than otherwise as the two dummy returns and an extra state return will be required.
If a couple marries during the 2014 tax year, each individual may want to review any Roth or traditional IRA contributions made earlier in the year as increased joint income could limit or prohibit a Roth IRA contribution and/or limit or prohibit the deductibility of a traditional IRA contribution. A Roth IRA contribution is fully allowed if individual income is below $114,000, phased out for income between $114,000 and $129,000 and prohibited for income above $129,000. Likewise, the income thresholds for married/joint filers for allowance, phase-out and prohibition range from $181,000 to $191,000. For example, two unmarried individuals, each with incomes of $100,000, would be allowed to contribute fully to their respective Roth IRAs. If, however, they married during the year, their combined income would place them over the upper threshold for Roth IRAs and both contributions would have to be re-characterized. Similarly, traditional IRAs are fully deductible for individuals who are not covered by an employer sponsored plan, or if they are covered, for income levels up to $60,000, phased out for income between $60,000 and $70,000, and not deductible for incomes above $70,000. Likewise, the income threshold for IRA deductibility for married couples in which at least one spouse is covered by an employer-sponsored retirement plan ranges from $96,000 to $116,000.
Capital Gains and Qualified Dividend Income
Capital-gains and qualified-dividend income are other areas for which combined joint income could also result in a higher tax liability. For taxpayers in the 10 percent and 15 percent brackets, there is no tax for realized long-term capital gains (assets held for more than one year) and qualified-dividend income. For taxpayers in the 25% to 35% brackets, long-term capital gains and qualified dividends are taxed at 15 percent. For taxpayers in the 39.6 percent bracket, capital gains and qualified dividends are taxed at 20 percent. A lower-income spouse who has significant capital-gains or dividend income could see that income taxed at much higher rates after marrying a higher-income spouse.
While the preceding discussion seems to place higher tax and reporting burdens on married couples, there is a situation in which matrimony could result in a tax advantage. If one spouse has significant realized or even unrealized capital losses and the other spouse has realized capital gains, filing jointly allows for realized losses of one spouse to be applied against realized gains of the other spouse. Securities trading at a loss could be sold and the losses used immediately against the gains of the other spouse instead of being carried forward, thereby accelerating tax savings. Realized losses that exceed gains can also be used against a maximum of $3,000 of ordinary income, though the $3,000 limit applies to individual and joint filers. In this case, we’re back to a negative as two individual taxpayers would have a combined ordinary income limit of $6,000, whereas a couple filing jointly would see the combined limit reduced to $3,000.
Tax planning can be complicated. Whether you are unmarried partners or married spouses, you should have a thorough discussion with a qualified tax professional in regard to your specific situation.
This article has been provided for informational purposes only, is not all encompassing and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Wells Fargo Advisors is not a legal or tax advisor. Be sure to consult with your own tax and legal advisors before taking any action that may have tax or legal consequences and to see how this information may apply to your own situation. Investments in securities and insurance products are: NOT FDIC-INSURED/NOT BANK-GURANTEED/MAY LOSE VALUE.
Wells Fargo Advisors, LLC, member SIPC, is a registered broker-dealer and a separate non-bank affiliate of Wells Fargo & Company, No. 17 in the DiversityInc Top 50.