The Tax Advantages of Remaining Unmarried

Not all tax rules that apply uniquely to married persons are more favorable than those that apply to single persons.

Two persons sharing their lives in cohabitation have significantly different tax planning issues than a married couple. What to do? Marry ... and enjoy the benefits of tax-free transfers between spouses, and other advantages, or remain unmarried... qualifying for two Section 179 deductions, two capital loss limitations, and exemption from related party rules that limit certain tax planning strategies? The “right” answer will require careful consideration of each couple’s circumstances.

Unmarried persons are now commonly able to provide health insurance benefits to their domestic partners. In a recent Private Letter Ruling, the IRS responded to an employer’s questions about the tax consequences of providing medical and dental benefits to its employees’ domestic partners. The Letter Ruling classifies domestic partners into two categories:

1) those who qualify as dependents for federal income tax purposes, so long as the relationship between the employee and the dependent does not violate local law, and

2) those who do not qualify as dependents.

If the domestic partner is a dependent, then the employee does not have taxable income when the employer provides medical benefits to the domestic partner. However, if the domestic partner is not a dependent, the amount by which the fair market value of medical coverage provided to the domestic partner exceeds what the employee pays for it is included in the employee’s taxable wages.

The Employer’s plan required an annual certification that the relationship between the employee and the domestic partner did not violate local law and that it met the other requirements for dependency status in the tax law.

Any non-taxable employee benefit that an employer could provide to an employee’s dependents without triggering income to the employee should work the same way as the medical insurance covered by the Letter Ruling. That would include, for example, meals or lodging furnished for the benefit of the employer under section 119, if one of the domestic partners was required to live in employer-provided housing and the non-employee domestic partner and children of either, all of whom qualified as the employee partner's dependents, lived there as well.

Marriage can actually be bad tax planning when two taxpayers have incomes that are both high and approximately equal; or when other factors -- such as capital losses are present and joint return limits would be lower than two separate return limits. In the case of capital losses, the benefit is $6,000 in two single returns versus $3,000 in a joint return.

Our firm uses state-of-the-art tax planning software that will illustrate the tax consequences of marriage or remaining single. Here are ten differences, in addition to those already mentioned, that should also be considered when calculating the cost (or benefit) of marriage.

1. Historically, the standard deduction for a married couple has been more than for an unmarried individual or Head of Household, but not double the amount for an unmarried individual. Temporary relief has been provided until 2010, but a “marriage penalty” returns to the standard deduction then.

2. Tax rate brackets for a joint return, above the 15% bracket, are not double those for unmarried individuals. For 2008, the 25 percent bracket for joint filers ends at $131,450, but at $78,850 for a single individual. Accordingly, two single individuals, each with an income of $78,850, will pay less tax than a married couple with income of $157,700.

3. At the other end of the economic spectrum, the Earned Income Credit is based on the total adjusted gross income of married persons reported in a joint return and the phaseout threshold for a married couple is only $2,000 higher than that for a single person. If a person with children qualifies for the maximum earned income credit, it makes no sense to marry if the other person’s income will cause the credit to be limited.

4. The childcare credit percentage is reduced from 35 percent to 20 percent as adjusted gross income increases. If a person incurring child care expense can use the 35 percent maximum credit ($3,000 for one child and $6,000 if more than one), and the income of the other person, if the two were married, would cause the credit to be reduced, marrying will have real economic cost.

5. The child tax credit phases out when “modified adjusted gross income” exceeds $110,000 on a joint return, whereas the phaseout starts at $75,000 for an unmarried individual. Unmarried persons with children, whose combined incomes exceed $110,000, should consider this additional cost of marriage.

6. Personal exemption phaseout points in a joint return begin at less than twice the individual return thresholds. For 2008, the phaseout thresholds are $159,950 for single taxpayers and $239,950 for married taxpayers whether they file joint or separate returns. Two single taxpayers can use significantly more of each exemption.

7. Itemized deductions start to phase out at $159,950 for 2008, whether the return is a joint return or the return of an unmarried individual. That means two single individuals; each with income above $80,000, can realize greater benefit from their itemized deductions by staying single.

8. The Alternative Minimum Tax exemption in a 2008 joint return is $69,950, less 25 percent of AMT income exceeding $150,000. That results in a zero AMT exemption at income of $382,000. In a single return, the exemption amount is $42,500, less 25 percent of AMT income exceeding $112,500. That’s a zero AMT exemption at $273,500. Two single persons could protect $547,000 from AMT . . . $165,000 more than the married couple. We do not expect the exemption to expire or be reduced, but we cannot know the amounts that Congress will agree on for years after 2008.

9. An exception to the passive loss limitation rules allows you to deduct up to $25,000 of losses from rental activities in which you actively participate. The allowable amount is reduced by 50% of the amount by which your adjusted gross income exceeds $100,000. Both the allowable loss and the phaseout are applied to the return of a single individual in the same way as the return of a married couple filing a joint return. That means that two single persons who are co-owners of a rental property might deduct up to $50,000 a year in rental losses, while a married couple would be limited to $25,000.

10. The tax law also encourages unmarried cohabitation among senior citizens. Social Security benefits are partially taxable when income exceeds $32,000 in a joint return and $25,000 in an individual return of an unmarried person. That allows two single persons to have $14,000 more income before their Social Security benefits become taxable.

Our mission as professional tax practitioners is to help you pay the least amount of income tax allowed by law, and help you understand any alternatives. We are highly knowledgeable about how filing status affects the tax issues that might be important to any couple...married or not...and can help you manage your tax issues to pay as little tax as the law allows.