Love and Taxes - Part 1

Ahhh ... Young love - and taxes?  We all acknowledge our responsibility to chip in and pay for our society - although there is a lot of disagreement about who pays how much and what gets bought with the tax dollars.  In terms of personal finance, taxes are especially important as a practicing attorney because you pay so darn much of your income in taxes.  Additionally, tax considerations can impact your other life decisions as a lawyer - like whether or not to get married - like the young lawyers in this recent e-mail that was sent to me:

I just want to say that I love your blog!  The rest of my family and friends, even the ones who are lawyers, do not seem to understand that a high income stream does not equal wealth because I have significant student loan debt and very little accumulated in assets. Constantly hearing "You can afford that" from the rest of the world (except my boyfriend) is a bit tiring and so its nice to have a reminder every now and then that I am doing the right thing by focusing on paying off my student loans.

I was wondering if you would consider doing a post about whether a married professional couple who file separately would be better for tax purposes.  My boyfriend and I are getting married next year when we both will be third years making $185K.  I am completely freaking out about taxes -- which no one else seems to understand -- and how they will increase (a) once we get married and (b) after any increases by Obama.  There seems to be a lot of literature on the Internet about how married filing jointly is the most beneficial and married filing separately is only very costly.  We both would need to itemize our deductions if we do married filing separately, but we'd have to do that anyway with our high incomes.  We don't plan on contributing more to retirement besides the 401K match for the first few years so any prohibitions against rolling IRA contributions to a Roth don't matter either.  And we'd start filing jointly once we have a kid.  

Anyway, you really seem to understand this stuff and I was wondering if you could weigh in if you thought it would be of interest to your other readers.  I have my boyfriend half convinced that we should just have a commitment ceremony next year and get legally married in the same tax year that I give birth.  Others think this is horribly un-romantic, but we aren't super religious and I don't really need the state up in my relationship status.

First, congratulations on recognizing that it is assets - not pre-tax salary income - that really makes you "rich".  You are definitely doing the right thing by focusing on paying off students loans and accumulating hard assets instead of giving in to the "you can afford it" crowd.  If ever your resolve weakens, just ask yourself how many of the "you can afford it" people would be there to pay your mortgage if your law firm job went away - most likely not too many.  Living a lifestyle based on your assets - not your salary - is the smartest way to go.

Second, congratulations on considering marriage!  I think that the situation that you describe is certainly of interest to many young lawyers and I'll take a shot at an answer.  If anyone else has any good advice, please feel free to add it in the comments.

As an initial matter, I can't predict with accuracy what is going to happen next year with regard to taxes - the "increases by Obama" that you mention - so I will stick with the current tax code in my analysis below.  (I'll touch a little on the potential tax increase in a follow-up post.)  As I see it, you really have three choices, 1) get married and file jointly, 2) get married and file individually, and 3) do not get married and file as singles.

First, let's compare married-joint with married-single - I notice that both you and your spouse will be making $185K.  That's enough that you are priced out of virtually all of the "beneficial stuff" like deductibility of student loan interest, etc., that are benefits provided "to all Americans".  (Yeah, there's maybe a little bitterness there.)  However, that actually makes our analysis simpler.

Let's take a look at the tax brackets for married-joint and married-separate:

2010 tax rates

Tax rate	Single filers	Married filing jointly or qualifying widow/widower	Married filing separately	Head of household
10%	Up to $8,375	Up to $16,750	Up to $8,375	Up to $11,950
15%	$8,376 - $34,000	$16,751 - $68,000	$8,376 - $34,000	$11,951 - $45,550
25%	$34,001 - $82,400	$68,001 - $137,300	$34,001 - $68,650	$45,551 - $117,650
28%	$82,401 - $171,850	$137,301 - $209,250	$68,651 - $104,625	$117,651 - $190,550
33%	$171,851 - $373,650	$209,251 - $373,650	$104,626 - $186,825	$190,551 - $373,650
35%	$373,651 or more	$373,651 or more	$186,826 or more	$373,651 or more

The first thing that we note is that the married-joint tax brackets are exactly double that of the married-separate.  Thus, at first glance there appears to be no benefit to filing as married-separate.

At second glance, we note that the tax code takes away a lot of benefits if you decide to file married-separate.  In the words of the IRS:

If you choose married filing separately as your filing status, the following special rules apply. Because of these special rules, you will usually pay more tax on a separate return than if you used another filing status that you qualify for

Most relevantly to your situation, your itemized deductions and personal exemption will also be at half-value.  Consequently, at first glance, there appears to be no advantage in filing as married-separately.  Additionally, there can be a detriment in several ways - for example, you can't "share" gains and losses when it comes to stock transactions, so one of you might be paying taxes on a gain when the other had loss that would have offset that gain if you would have been allowed to consider the gain and loss together.

However, there can be an advantage to filing married-separate in a few isolated situations (article 1, article 2, article 3, article 4, article 5), but they don't seem to apply in your situation.  For example, there is no indication that either of you have huge unreimbursed medical expenses, that there is a concern about auditing or fraud, that one of you is subject to a collection of tax return, etc.  Some posts have also mentioned that there might be an advantage to filing as married-separate when it comes to state taxes in some states, but there isn't in mine.

Note that this is specific to your personal situation - specifically, both you and your spouse make about the same amount of money - and it's enough to put you in a high bracket.  On the other hand, if one of you made significantly less than the other, then it would be very advantageous to file married-joint because you could take advantage by effectively putting some of the higher income into the lower bracket of the other person.

To help you get a handle on this, I recommend the tax caster available at turbo tax.  This will let you get a quick and dirty estimate.  Of course, if you actually use turbo tax, you can actually have the program run the options of married-joint and married-single and see how it really works out for your actual data.

When I plug in $185K as income for both you and your spouse as married-joint, I get a total tax liability of $95,634 - with $1,113 of it coming from the AMT.  However, when I switch to married-single, the tax liability is $47,817 - each! - which is exactly half of the previous amount.  This agrees with our determination above that there is no advantage to filing as married-separate.  Feel free to plug in your actual deductions and other aspects to get more accurate insight.

Consequently, there does not appear to be any advantage to filing as married-single, so let's take that option our of contention.  In Part 2, we will consider filing as married-joint as opposed to single.