Example. Suppose a husband and wife each earn wages of $50,000 in 1999, for a combined income of $100,000. If both spouses were able to file individually, each would incur a federal income tax of $8,686. All of the taxable income on each return is taxed at the 15% rate, and the taxpayers could each claim a $4,300 standard deduction (assuming that the taxpayers do not itemize deductions). Filing a joint return, $44,250 of the couple’s taxable income will be taxed at the 28% rate and they will be entitled to a standard deduction of just $7,200 (as compared to $8,600). This illustrates how some of the tax law disparities trigger a penalty. By filing a joint return, the couple will incur a Federal tax of $18,855, which amounts to a $1,483 penalty ($18,855 – $17,372).

Conversely, suppose that in December 1999 a single taxpayer earning $50,000 marries a college student with no income. By filing a joint return reporting $50,000, as opposed to a single return reporting the same, he would immediately reduce his tax liability by $3,091. This becomes a marriage bonus, through which a taxpayer benefits by sheltering some income through the exemptions and deductions available to a spouse.

Critics of the marriage penalty complain that various tax credits are phased out more quickly for married filers than for single filers (e.g., the earned income tax credit, the child tax credit, and various education tax incentives). They claim the marriage penalty is an unfair and discriminatory tax; the fact that this penalty is imposed in a less transparent fashion does not, in their eyes, make it less objectionable than an outright tax on marriage.

Joint and Several Liability

There is another provision of the tax code that imposes a form of penalty on married taxpayers: Joint filers are held to share “joint and several liability” for all of the tax liability attributed to their joint return [IRC section 6013(d)(3)]. For taxpayers unaware that their spouses omitted income or took excess deductions, this liability can be quite harsh. Prior to the enactment of the innocent spouse provisions, a taxpayer could not ask the courts for relief from joint and several liability when a joint return was filed. Case history has shown that, even under circumstances in which a spouse seemed to have no knowledge of any fraud or tax evasion, the “innocent” spouse was found jointly liable [Merceda C. Pershall v. Comm’r, 18 TCM 612 (1959)].

In response, Congress has enacted and amended laws to protect a spouse who had no knowledge of the errors on the return. IRC section 6015 requires that—

A taxpayer must claim “innocent spouse” status within two years after the collection activities have begun, using the proscribed form [IRC section 6015(b)(1)(E)]. The outcome of the claim, however, will be difficult to predict: The courts have applied the innocent spouse relief provisions inconsistently. Oftentimes, the courts have found that an error in computation was not erroneous. In one such case, the Tax Court refused relief to a taxpayer whose husband reported income but mischaracterized it as foreign source [Whitten v. Comm’r, 86 TC 802 (1991)].

In practice, the courts have been reluctant to grant relief to many innocent spouses, claiming that it is not inequitable to hold the innocent spouses liable for the tax if they received significant benefits from the income (e.g., spending the money). In a Second Circuit appellate decision, a spouse found to have received no significant benefit was still denied relief on the grounds that the underreporting of income had resulted in a substantial increase in her net worth [Sam & Eva Berman v. Comm’r, 95-1 USTC para. 50,117 (CA-2, 1995) aff’g 66 TCM1798 (1994)].A taxpayer who files a joint return can be held liable for any tax fraud on the part of the spouse and would need to satisfy the complex relief provisions to avoid any personal tax liability attributable to the fraud. In addition, the current statute provides that when one individual seeks innocent spouse relief, the other spouse must be notified and may become a party to the proceedings [IRC section 6015(e)(4)]. An August 2000 Tax Court decision held that the former spouse of the petitioner seeking relief was entitled to notification and an opportunity to intervene and challenge the petitioner’s claim to relief [Kathy King v. Comm’r, 115 TC No. 8 (2000)]. One might ponder the soundness of a statute that provides relief to innocent spouses while containing a caveat that requires notification of the party that generated the liability.

Many discussions have analyzed the impact of the marriage penalty on social decisions: Do the financial and tax consequences impact the decision to marry? For example, an unmarried couple that cohabits avoids the income taxes imposed by the marriage penalty but may be at a disadvantage for gift and estate tax purposes. In a discussion of the marriage penalty, all the financial aspects of the decision to marry should be considered and evaluated.

Current Developments

Despite attempts to the contrary, the marriage penalty and joint and several liability have yet to be resolved. The IRS Reform and Restructuring Act of 1998 (P.L. 105-206, 7/22/98) codified the relief provisions that allow taxpayers to claim innocent spouse status to obtain relief from joint liability.

The U.S. House and Senate have passed a number of bills with provisions affecting the marriage penalty, including the Marriage Tax Relief Act of 2000 (S. 2346), the Marriage Tax Relief Reconciliation Act of 2000 (H.R. 4810), and the Taxpayer Refund and Relief Act of 1999 (H.R. 2488); many were vetoed by President Bill Clinton. During last year’s election campaign, congressional and presidential candidates brought these issues to the forefront, promising resolution. Proposals on Capitol Hill take many forms: Some would institute a deduction on a joint return for a portion of income; others would increase the standard deduction or mandate individual filing for all taxpayers.

State and local governments are also getting involved. Last year, Governor George Pataki and the New York State Assembly and Senate passed a bill increasing the standard deduction for married couples, a start at eliminating the marriage penalty altogether.

It is impossible to predict whether the marriage penalty will be reformed in the near future, but significant changes are likely. Meanwhile, proper planning can enable married taxpayers to reduce or avoid the penalty or, if possible, take advantage of the bonus. Practitioners that understand the relevant tax provisions can provide a significant service to their clients.

Editors:
Milton Miller, CPA
Consultant

William Bregman, CFR, CPA/PFS

Contributing Editors:
Theodore J. Sarenski, CPA
Dermody Burke & Brown P.C.

David R. Marcus, JD, CPA
Marks, Paneth & Shron LLP

©2009 The New York State Society of CPAs. Legal Notices