Tax Benefits for Unmarried Home-Owners and The Marriage Tax Penalty

Becky and I are getting hitched later this year and along with the joy of marriage comes a couple of tax implications.  As far as the government is concerned when it comes to taxes, if you’re married on December 31st of the tax year, you’ve been married for the entire tax year.  This means filing our 2016 taxes (in 2017) will be the first time we have the opportunity to file as a married couple.  Out of curiosity, I ran our 2015 tax numbers through a joint return to see what would change and found out we actually would have owed more money!  More taxes?  I thought getting married was supposed to lower the overall tax burden of a couple?

It turns out the primary reason we’ll end up owing a little more going forward is because of a little tax trick we’ve been taking advantage of ever since we bought our house.  I’ll share exactly what we’ve been doing over the past couple years to save money on taxes as an unmarried couple and find out exactly how much this marriage is going to cost us (aside from the wedding thing of course).

Strategically Using Itemized Deductions

The key to understanding why we come out ahead as an unmarried couple is understanding how tax deductions work.  In general, you owe federal taxes on your earned income minus deductions, but the IRS gives you two options for calculating these deductions.  You can either take the “standard deduction” of a pre-determined amount ($6,300 for single-filers in 2015), OR you can add up (itemize) all of your qualifying deductions and use that instead.  For the most part, you simply want to take whichever is higher in order to reduce the total amount of taxes owed.

As Becky and I were not married at the end of 2015, the IRS considers us as having no tax link of any kind despite us handling our finances in a joint manner (for the most part).  Part of those joint finances includes the extremely large purchase we made a couple years ago in the form of a house.

We’re both co-signers on the mortgage and both of our names are on the title of the house, but we can’t simply both take the full deduction that comes with paying mortgage interest (wouldn’t that be nice!).  Instead, we are each only allowed to deduct the portion of the deductible expenses that we paid for.

The “trick” is that one of us can pay for ALL of the deductible expenses such as mortgage interest and real estate taxes!  For us, this is easy because our finances are fairly co-mingled.  If I’m paying for all of the mortgage, then Becky ends up paying for all the groceries or whatever other expenses come up.  In the end, we still end up contributing an equal amount to our joint expenses, but by making the higher earning individual specifically pay for any deductible expenses, we can come out ahead at tax time.

See the “More than one borrower” part of this IRS document for more info: IRS Publication 936

Pulling this off will be a little trickier if you don’t share most expenses between the couple, but might be worth the extra work if it could save you thousands on your taxes!  Let’s see how much of a difference it makes for a sample couple below:

A Simple Example

Let’s say person A and person B buy a house together and the interest + property taxes will end up being above the $6,300 standard deduction.

  • Person A Income: $80,000
  • Person B Income: $40,000
  • Mortgage Interest: $8,000
  • Property Taxes: $2,000
  • Total Deductible Expenses: $10,000

Taxes Owed After Splitting the Deductible Expenses

If both people split the deductible expenses right down the middle, person A will have $5,000 in deductible expenses (half of $10,000), and it makes more sense for them to take the $6,300 standard deduction.  Same thing for Person B, so no one gets any benefit from having the deductible expenses that come with having a mortgage.

  • Person A Taxable Income: $69,700  ($80,000 – $6,300 standard deduction – $4,000 personal exemption)
  • Person A Taxes Owed: $13,219
  • Person B Taxable Income: $29,700 ($40,000 – $6,300 standard deduction – $4,000 personal exemption)
  • Person B Taxes Owed: $3,994
  • Total Taxes Owed: $17,213

Taxes Owed After Having Person A Pay for All Deductible Expenses

Person A now has $10,000 in deductible expenses, while person B has none.  Person A can now itemize their deductions to save on taxes while Person B will still be able to take the full standard deduction.

  • Person A Taxable Income: $66,000  ($80,000 – $10,000 itemized deduction – $4,000 personal exemption)
  • Person A Taxes Owed: $12,294
  • Person B Taxable Income: $29,700 ($40,000 – $6,300 standard deduction – $4,000 personal exemption)
  • Person B Taxes Owed: $3,994
  • Total Taxes Owed: $16,288

Amount Saved in Taxes = $925

As you can see, by putting all of the deductible expenses on the tax return of the higher income person, the total amount of taxes owed for the couple was reduced by $925!  Placing all of the deductions on the person with the lower income’s return would have also been better than splitting it down the middle, but would have saved $370 less because the higher income person falls in a higher marginal tax bracket.

This Doesn’t Just Apply to Home Deductions

The same trick above can be used for pretty much any itemized deduction in which either person can be the one making the payment for it.  Another common one that comes to mind is the deduction for charitable giving.  Assuming you are sharing finances anyway, why not have the higher income individual do all of the charitable giving for the household?  The same amount gets given to the charity and the total household expenses stay the same, but you can now save additional money on federal taxes each year!

I’d like to share a statement I heard recently about the US tax code (unfortunately, I don’t remember the source so I’ll be paraphrasing):

About 0.5% of the tax code is dedicated to telling you how much you should owe.  The other 99.5% describes different ways to reduce the amount you owe by performing economic actions the government wants to incentivize such as buying a home or starting a business.

If you happen to doing any of the things the government wants to incentivize (such as purchasing a home), then read up or consult an expert to make sure you aren’t paying more taxes than you need to be!

The Marriage Tax Penalty

As you can see in the example above, the unmarried couple was effectively able to deduct $16,300 from their taxes by putting all of the deductions on a single person’s tax return rather than split evenly and only deduct the standard $12,600.  If you understand this part, then it should be easy to understand the tax penalty part that applies to certain couples.

First, let’s look at what changes tax-wise when two people get married.  Right off the bat, the IRS highly encourages the couple to file jointly by adding rather large penalties to a married couple that chooses to file separately.  One of the most obvious changes is the cut-offs for the different tax brackets.  Up until the married couple makes $151,200 (the top of the 25% bracket) everything remains the same.  Beyond that point, the single-filers get higher tax-bracket cutoffs causing higher-earning married couples to be penalized.  An additional penalty is the prevention of one couple taking the standard deduction while the other itemizes, even when filing separately.  There are very specific cases (such as certain student loans) where filing separately as a married couple might make sense for tax purposes, but the majority of married couples should be filing their taxes jointly if they want to minimize taxes.

As having a single itemized and a single standard deduction is the basis of the “trick” I outlined above, you can see how it no longer applies after marriage.  In the example above, if Person A and B get married, they can either take the married standard deduction of $12,600 or itemize $10,000 worth of deductions.  Obviously, $12,600 > $10,000 but unfortunately both are lower than the $16,300 we were able to deduct before they got hitched.  Because their two incomes are combined for the married tax brackets, it does lower the tax bracket on a small portion of the income and the difference (penalty) between our optimal filing above and the standard married filing is only $150 in their case.

The couple in this example would save $150 on taxes if they weren’t married!

A tax penalty isn’t always the case in marriage though, and there are many times that getting married can be beneficial come tax time.  If one member of the couple makes more than the other and falls in a different marginal tax bracket, its entirely possible you will save money by getting married!  If we look at the two incomes we used in the example above ($80k and $40k), but remove the deductions, Person A and B getting married would actually save $775 versus filing separately as singles!

This couple saved $775 on taxes by being married!

Check Out the Marriage Tax Calculator if you want to check how much a marriage impacts your tax situation.

Our Own Upcoming Marriage Penalty

As I mentioned in the opener, we’ve been taking advantage of the unmarried tax trick when it comes to shared deduction expenses for a couple years now.  Once we officially tie the knot later this year, we’ll no longer be able to use the trick and will be forced to file jointly.  The penalty I calculated for our 2015 taxes we recently filed was ~$1,500 if we would have plugged the exact same numbers into a joint return as we did to our individual returns.  Now assuming our tax situation doesn’t change too drastically, this number will reduce over time as our deductible expenses (mostly mortgage interest) reduce each year, even more so because we recently refinanced our mortgage to a lower interest rate.

It’s unfortunate that getting married will come with an extra tax bill every year, but it wasn’t a big enough number for us to put off the marriage to a later date.  How big would a marriage tax penalty have to be for you to consider being legally single for tax purposes?

This high-earning couple would owe Uncle Sam over $8,000 extra in taxes per year simply for being married!

10 thoughts to “Tax Benefits for Unmarried Home-Owners and The Marriage Tax Penalty”

  1. On the subject of itemizing deductions, depending on how your state processes property tax payments, you can double up and maximize your itemized deductions.

    The IRS pretty much always uses cash accounting for personal income tax returns, and this applies here.

    If your state has a property tax payment near the end of the year, but lets you pay it either at the end of the year or early next year, you can double up (this is similar to the fellowship payments discussion we had, but the flow of money is reversed). In year 0, you don’t make a payment at the end of the year, and you make a payment at the beginning of year 1. Then you also make another payment at the end of year 1. And finally you don’t make any payments in year 2.
    This way you don’t “waste” as many payments to overcome the standard deduction.

    I don’t itemize so I don’t recall all the things you can itemize, but you can of course apply this principle to other deductions, such as setting aside money for charitable donations over several years, and then donating all of it in one year.

    1. Great addition! I’ve heard this called “Deduction Bunching” before in an article I read about maximizing charitable giving tax benefits. If your state allows the flexibility to pay property taxes across calendar years then that’s another opportunity, but be sure to run the numbers to make sure it’s better to bunch things together rather than split evenly. If something like interest is going to put you above the standard every year, you’ll want the additional deductions to hit the higher tax brackets which may mean splitting evenly rather than bunching in certain cases.

      I’d have to double check, but I’m pretty sure our property taxes are collected in Spring/Fall and wouldn’t be able to push some of it over to the next/previous year.

      1. There’s a few strategies for maximizing charitable giving. Here’s an article I wrote about maximizing giving impact AND tax savings.

        What I do is I make an annual contribution to my donor-advised fund at the end of the year (last week of December) . I transfer over investments with the lowest cost basis. When the new year comes around, I can file my taxes as early as February to claim the entire amount on my tax returns.

        – donating low cost basis investments = no capital gains tax
        – rebalancing your portfolio = lowering long-term tax liability. This is great because I have many investments with 200-300% gain so all that is tax-free now. I donate then buy back the same investments at higher cost basis.
        – easier tax filing because you only need to track contribution to DAF instead of multiple donations to charities
        – tax write off (itemized deduction) within 2-3 months of contribution
        – $ in DAF and continues to grows over time = more to give away
        – ability to send anonymous donations via the DAF
        – and many more!

  2. Yup, the last example applies to many married working professionals in the Bay Area. $150k+/year salary per person is pretty common.

    I have friends who got “married” but didn’t file the legal paperwork for this very reason. You can take care of the other legal paperwork like estate planning, children, and medical directives. It raises the question what defines a “marriage” if two people did in fact put together a wedding, got “married” infront of witnesses, have kids, and live under the same roof as a family.

      1. That doesn’t sound like something that would fly in states like California with “no fault divorce” where properties are split 50/50. I can see lots of people pissed about being considered “legally married” for just cohabiting.

        You have:
        – people who live together but don’t want to get married (for personal or tax reasons)
        – people who are married but don’t live together
        – people who are married but have an open marriage
        – people who live together but are married to someone else
        – people of the same sex wanting to get married but can’t

        Love/relationship/marriage is complicated… the law can’t and shouldn’t force people to be “married” just because they live together.

      2. Looks like only a small number of states recognize the common law marriage, but it seems to be set up as a benefit for those that want to be considered married without going through the process of getting a marriage license.

        Based on some quick reading on the subject it looks like it’s fairly easy to declare that you are “two independent people living together with no intention of getting married” in writing to avoid the common law marriage coming into effect.

        Good to keep in mind if you decide to save on taxes by staying single and happen to live in a common law state.

    1. Yeah, I can imagine the Bay Area would yield high enough salaries that staying legally single might be worth it for tax purposes.

      I’m not sure why they don’t just make the tax brackets line up for 2-singles vs. a married couple, but the argument is probably that a married couple has less overall expenses for the same quality of living or something. Might be a little dated given how common it is for unmarried couples to be living together (still not a huge % though).

      The main benefits of marriage seem to be avoiding some of the paperwork you mentioned, but then it comes down to a cost vs. effort decision.

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