Wealthy Couples Can Save on Taxes If They Divorce

Extremely wealth married couples with roughly equal incomes pay more in taxes than they would if they were single.

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As a rule, the government tries to promote family togetherness through the tax laws and other means. However, the tax rates that took effect in 2013 as a result of the "fiscal cliff tax deal" do the opposite for some affluent taxpayers.

The federal tax law has long had a "marriage penalty"--that is, married taxpayers must pay more than singles at some income levels. There is also a "marriage bonus"--that is, some married couples pay less than single individuals with the same total income.

Because of the way the tax brackets work, a marriage bonus most often results when two partners have widely diverging incomes, and a marriage penalty when they have roughly equal incomes. There can be a bonus with differing incomes because the addition of one partner’s small income (or no income where one partner does not work) to the other partner's much higher income is usually not enough to lift their joint return into a higher bracket. On the other hand, combining two incomes of equal or similar size into one joint tax return can lift the return into a higher bracket. The most significant marriage penalty is for two-earner couples who each have very high similar incomes.

Example: Abe and Zera are a married couple who each earn $400,000 per year from their jobs as hedge fund managers. Let's assume that they take only the standard deduction. In 2013, they would each pay $114,118 in income tax, for a total of $228,236 if they filed as single taxpayers. If they file as married filing jointly, their total tax would be $288,207. That's almost $60,000 more than if they were single.

Why the difference? As shown by the following chart, if they file as single, the top income tax rate for each partner is 35%. If they file jointly, their top bracket is 39.6%.

Tax Bracket

Income if Single

Income if Married Filing Jointly

10%

Up to $8,925

Up to $17,850

15%

$8,926 to $36,250

$17,851 to $72,500

25%

$36,251 to $87,850

$72,501 to $146,400

28%

$87,851 to $183,250

$146,401 to $223,050

33%

$183,251 to $398,350

$223,051 to $398,350

35%

$398,351 to $400,000

$398,351 to $450,000

39.6%

All over $400,000

All over $450,000

What about staying married and filing as married filing separately? This doesn't solve the problem because, as the following chart shows, at higher income levels there are separate tax brackets for married people filing separately that are not as favorable as those for singles.

Tax Bracket

Income if Single

Income if Married Filing Separately

10%

Up to $8,925

Up to $8,925

15%

$8,926 to $36,250

$8,926 to $36,250

25%

$36,251 to $87,850

36,251 to $73,200

28%

$87,851 to $183,250

$73,201 to $111,525

33%

$183,251 to $398,350

$111,526 to 199,175

35%

$398,351 to $400,000

$199,176 to $225,000

39.6%

All over $400,000

All over $225,000

From our example above, if Abe and Zera both filed married filing separately, they each would pay $129,807 in income tax, for a total tax of $259,614--almost $30,000 more than if they filed as single taxpayers.

The moral: Extremely wealth married couples with roughly equal incomes could save substantial income taxes by divorcing.

August 2013

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