Taxes – Marriage Penalty and The Alternative Minimum Tax

I have finally received all of the tax forms for my wife and me: W-2s, savings accounts, brokerage accounts, etc. For the past 6 years I’ve been using TaxCut to do my taxes (one year I tried an accountant, but it seemed that I lost money because he saved me nothing and I had to pay him a lot more than the software cost). TaxCut has treated me well except for making me purchase an extra state when I worked in multiple states. However, this year they jacked up the price quite a bit: $69.99 retail for the state + e-filing. Wow! I might start looking into an accountant if I can find one for $100.

I’m not at the worst part yet! I entered in all of our tax info and followed the upper right hand corner that tracks my refund (or owe!). Enter in my W-2, a grand in refund, enter my wife’s w-2, owe four grand, etc. Up and down it goes as I progressed along the screens when suddenly the next button (and the end of credit) caused the upper right hand corner to show us owing around $15,000! I was shocked! I probably spend 2 hours recalculating and doing the numbers by hand. I even found a site that helps you calculate your owed taxes (check it out..pretty helpful).

After going through stages of grief (denial, anger, bargaining [cheating], depression, and acceptance) I finally figured out what is going on.

Three things caused our high tax bill:
1. My wife had a nice tax bill of $6,000 (off setting my $500 refund). This came from her withholdings being too high. We’ve already reduced them down 2 points.

2. Filing as married, as opposed to single, creates an additional $5000 in taxes. This took me quite a while to figure out, but after doing some calculations by hand and using the above mentioned website I came to the realization that our total is like a single person filing with our total income (technically not as bad, but much worse than two single people filing). For example, say two married people make $200,000 a year each. Filing single, they each owe $52,086. Filing married they owe $112,206…a difference of $8,070. The reason is because you pay only 10% taxes on the first $8,000 made, 15% on the next $22,000, etc. Filing married mostly combines the incomes, thus only one income gets the progressive tax.

3. The Alternative Minimum Tax hit us by filing together. Filing single we wouldn’t have been hit by it.

One may ask why not just file as two singles. Legally you can’t. You either file as “Married, Filing Jointly” or “Married, Filing Separately.” The latter status has even a worse tax hit!

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The Tax Man Cometh

I just received my final tax forms from my company, mutual fund holdings, etc. I use TaxCut and have found over the years that it has gotten better and better (at least the interface has gotten prettier). As usual I imported last years return and started filling in all the 1099’s and W-2s. One difference this year is that I’m no longer single (got married last summer). Now, I was expecting back around $6,000 based upon the fact that I over paid Social Security due to a job switch in October (basically, you stop paying social security once you hit $94,200. However, if you switch jobs the new company usually considers you starting from zero…won’t get it back until tax time). When I finished the last entry I looked up in that little right corner box and saw those devilish red colored numbers saying I owed $654 to the federal government!

I kept going over in my head what could have I done wrong! An extra zero here, a double entry there? The next day I figured it all out by entering both my wife and myself as single. Lo and behold I got back around $5,500 and my wife got back $500. My missing 6 grand.

What happened was since my wife and I earn close to the same salaries our combined income pushed us into the next tax bracket. She was in the 28% bracket and I was in the 33% bracket. Combining us together essentially made all of her income taxed at the 33% level. I always heard about the marriage penalty, and now I had it slap me in the face.

Here is the federal tax schedule:
http://www.irs.gov/formspubs/article/0,,id=150856,00.html

I jokingly said to my wife that she was costing me 6 grand a year…she coyly smiled and said to just wait because she has her eye on a few new designer handbags! Gulp!

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