For Richer or Poorer
You say that you’re a cynic about all things--society, taxes and even love?
You can get a big bang out of the tax law, if you are willing to let that cynicism take over and guide your life--or rather your marital status--on a practical, rather than romantic, course.
No doubt every true cynic wonders: Do I need to marry or divorce? It depends. In some circumstances, the words “I do” open a trunk full of tax savings. In others, severing the bonds of matrimony loosen thousands of dollars in federal tax deductions.
Ironically, while it has long been the intent of Congress to alter individual behavior through tax breaks--spurring home ownership through tax deductions and encouraging procreation by way of personal exemptions and credits, to name a few--the nuptial incentives written into today’s tax code appear decidedly impolitic.
Two-income couples can hardly afford not to divorce before sending their progeny off to college, for example. Meanwhile, a single man or woman with significant investment or real estate gains would win big by hooking up with a terminally ill suitor.
If you do it all--marrying and divorcing at all the right times--your tax savings are certain to amount to tens of thousands of dollars over time. Need proof?
Consider two hypothetical couples, Stan and Sue Sincere and Clark and Claire Cynic. Both the Sinceres and the Cynics are smart, successful and deeply in love. Conveniently, the couples also live parallel lives.
Stan and Sue marry in 1997, while both are working and earning $40,000 each. They learn the joys of “married filing jointly.” Their $80,000 in combined income lands them a $13,635 federal income tax bill.
The Cynics, meanwhile, live together without marrying and file separately. They each pay $6,099 in tax--a total of $12,198--or $1,437 less than the Sinceres.
In 1998, the marriage penalty will rise a touch to $1,477.
Over the course of five years, the Cynics save roughly $7,400 in federal income tax by simply not saying “I do.”
Five years later:
The Sinceres and Cynics are even more successful. Stan and Sue earn $60,000 each--a total of $120,000. So do Clark and Claire. The Sinceres pay $25,074 in tax. The Cynics pay $23,398--$1,676 less each year.
The next year:
Now the couples, still blissfully happy, decide it’s time to have kids. Oddly enough, both Sue and Claire discover that they’re pregnant with triplets. After investigating the cost of having round-the-clock nannies, the mothers-to-be decide to quit their jobs and live on one income.
Finally, the Sinceres’ marital status pays off: Their tax bill is just $5,981. The Cynics, on the other hand, realize that if they remain unwed, they’ll pay $7,849--or $1,868 more than the Sinceres.
Why? Among other things, Clark can’t claim Claire as dependent because she’s technically unrelated to him, and they can’t meet other dependency tests. (Some states, such as North Carolina, also ban living together unwed. The IRS only allows tax deductions for activities that are considered legal in your state, so that nixes claiming a live-in partner as a personal exemption.)
The Cynics have a small but tasteful wedding ceremony in the maternity ward. Their families, assuming the wedding is for the sake of the children rather than Uncle Sam, are delighted and shower them with gifts.
Six years later:
All of the kids have started school, and Sue and Claire decide to go into business as fertility consultants. Their part-time self-employment income nets them each $40,000. Their husbands, meanwhile, are now earning $80,000 each.
The Sinceres pay $21,627 in federal income tax.
The Cynics amicably divorce. Clark pays $17,508; Claire pays $2,243--a total of $19,751. Divorce nets the Cynics a tax savings of $1,876.
Twelve years fly by:
The Sinceres’ triplets are about to start college. But with $120,000 in joint income, Stan and Sue can’t qualify for any of the lucrative tax breaks--such as the Hope tax credit or the lifetime learning credit--that were passed in the 1997 tax law. They pay $22,327 in income tax.
Meanwhile, Claire Cynic, still earning $40,000 annually, is able to claim education tax credits for her passel of college freshmen. She pays just $1,625 in tax. Clark pays $17,508 on his $80,000 salary. Together, they owe $19,133--$3,194 less than the Sinceres.
As it happens, Claire and Sue have a mutual friend, named Anna, who is a successful middle-age woman. Anna owns a home on the ocean, which has risen in value from a mere $100,000 when she bought it back in the 1970s, to an amazing $600,000 today. She also has a stock portfolio that has gained $100,000 in value.
At this stage in her life, Anna would like to quit her job, sell the house and investments and simply live off the income. But she has a problem: Taxes. If she sells the house, she’ll owe capital gains taxes on half of the $500,000 gain--about $50,000 (20% of $250,000) total. In addition, she’ll owe another $20,000 in federal capital gains taxes if she cashes in her investments at a $100,000 profit.
She also mentions that, although she’s not in love, she has received a marriage proposal from an ailing gentleman who wants to marry her before he dies. Anna asks her friends Sue and Claire for advice.
Sue is unequivocal: Anna can’t marry if she’s not in love. As for the tax questions: “Hey, taxes are just a part of life.”
Tax-savvy but unsentimental Claire advises her friend to wed before she sells the house. Thanks to the 1997 tax law, if she sells the house while married, the entire $500,000 gain is excluded from tax, she explains. That would save Anna the $50,000.
Meanwhile, after the wedding, the stock portfolio would also become community property. When Anna’s ailing spouse dies, the portfolio would revert to Anna--but with a stepped-up tax basis, says Philip J. Holthouse, partner in the Los Angeles tax accounting firm of Holthouse Carlin & Van Trigt. At that point, Anna could sell her stocks without declaring a capital gain.
The net tax benefit of Anna’s brief foray into wedded bliss: $70,000.
Sincerely Cynical Although this entire saga of the Sinceres and Cynics is clearly tongue-in-cheek, the tax facts are all accurate, says Stuart Gill, senior tax research analyst at CCH Inc., a Riverwoods, Ill.-based publisher of tax information. Gill ran the numbers through CCH’s computer tax-analysis software, which factors in the effects of deductions, personal exemptions, credits and the alternative minimum tax, where applicable. For simplicity’s sake, all the examples assume that the couples take a standard deduction.
Would any couple actually change marital status just to save on taxes?
“To be frank, I considered it,” says the recently married Gill. “Before we were married, we were getting a nice refund every year. Now we owe tax.”
