After months of negotiations, lawmakers in Washington finally succeeded in crafting a tax reform package that Republicans could agree on. New tax laws will take effect in 2018, and investors are excited about the huge decline in the corporate tax rate and its potential impact on business profits.
Yet for individual taxpayers, the most important change in the new tax law hasn't gotten a lot of attention. Amid wrangling over tax credits, higher standard deductions, and changes in deduction rules, the biggest change that upper-middle class and high-income taxpayers will see is the elimination of the marriage penalty. That provision by itself will save many married couples thousands in taxes by producing the biggest tax rate drop for individuals in the legislation.
What the marriage penalty is
The marriage penalty has existed for a long time and is a result of the differences among tax brackets for single and joint filers. Under the existing law that will apply to 2017 tax returns, the income thresholds for joint filers in the 10% and 15% brackets are exactly double what the regular single rates are. That ensures that under no circumstances will people in those brackets pay more in tax if they get married than they would if they remained single.
However, higher brackets under existing law aren't set up that way. For instance, the upper end of the 25% bracket for single filers is $93,700. That would imply a bracket top at $187,400 for joint filers in the absence of a marriage penalty, but the actual upper end is at $156,150. That means that more than $31,000 of taxable income gets taxed at the next higher tax bracket of 28%, costing those taxpayers nearly an extra $1,000 in taxes.
What tax reform did to help upper-middle and high-income married taxpayers
The Congressional tax reform package sought to eliminate the marriage penalty for all but the highest-earning taxpayers. Under the proposal, the upper income limits for joint filers in five of the seven tax brackets will be exactly double the limits for single filers.
That yields some particularly big tax benefits for certain taxpayers. Consider the following examples:
- A couple with $165,000 in taxable income will have a maximum tax rate of 22%. That's down from the 28% that couple would pay under current law on the final $6,850 of income they earned, on top of the tax rate reductions of three percentage points on the income that used to fall in the 15% and 25% tax brackets.
- The biggest winners are couples making between roughly $240,000 and $315,000 in taxable income, because the extension of lower tax rates in that range is the greatest. For instance, take a couple with $300,000 in taxable income. Under current law, that couple would pay 33% tax on more than $62,000 of their income, with 28% taxes applying to another nearly $82,000. The new law, by contrast, imposes a 24% top rate on $135,000 of that income, with the remaining $9,000 getting an even better 22% rate. The savings of as much as nine percentage points on the tax rate -- the difference between 33% and 24% -- amounts to thousands of dollars of savings for those taxpayers.
Those taxpayers with lower incomes won't see a lot of benefit from the new provisions, mostly because they've already had tax brackets that sought to eliminate the marriage penalty. For them, the benefits of tax reform will largely come from the tax rate decreases and higher standard deductions that the legislation provides.
The net impact of tax reform
Married couples in these higher tax brackets won't necessarily get to reap all the rewards of these favorable tax changes, because other provisions might apply to offset those savings. One example is the limitation on state and local tax deductions, which are likely to result in higher taxable income for many couples at these income levels.
Nevertheless, the change could be one of the biggest benefits of tax reform. The savings are big enough that unmarried couples who've held off on tying the knot due to past marriage penalty concerns might want to rethink their life planning in light of the new rules.