A trend I noticed this year with my clients who are in same-gender marriages: an unpleasant surprise at tax time because of changes to their paycheck withholdings in 2014.
Some of my clients went from getting a refund of several-thousand dollars in prior years to owing several-thousand dollars on their 2014 tax return.
What’s Going On?
(For all of these examples, I am using the withholding tables in Publication 15 for 0 exemptions.)
This issue has everything to do with how much income tax is withheld from a person’s paycheck. Contrary to what the H&R Block and TurboTax commercials imply, there’s no magic that a preparer can work to give people a bigger refund — tax refunds are almost always determined by how much tax was withheld from wages during the year.
With paycheck withholdings, there are two withholding options: single or married. More taxes are withheld under the single rates than the married rates. Note: this refers only to how much tax is taken out of paychecks, not to how much tax a person will owe on their tax return.
Here are examples of how this affects couples in same-sex marriages:
EXAMPLE 1
Lloyd and Floyd are married. In 2013 (the year the Supreme Court struck down the Defense of Marriage Act), Lloyd and Floyd’s employers considered them single for withholding purposes and withheld at the single rates.
Lloyd makes $1,000 per payday and is paid twice a month. Floyd makes $2,000 per payday and is also paid twice a month. Assume that they claim 0 exemptions.
Using the withholding tables in IRS Publication 15, Lloyd will have $118 withheld from his paycheck each payday ($2,832 per year) and Floyd will have $303 withheld each payday ($7,272 per year). Total withholding between the two of them is $10,104.
Let’s assume Lloyd and Floyd file as married in 2013, using the standard deduction. No kids, no credits, etc.
Their gross income is $72,000. Exemptions of $3,900 each = $7,800. The standard deduction for a married couple in 2013 was $12,200. Their taxable income is: $72,000 – $7,800 – $12,200 = $52,000. The tax owed on $52,000 by a married couple in 2013 was $6,911.
Lloyd and Floyd would have received a refund of $3,193. ($6,911 tax liability minus withholding of $10,104.)
EXAMPLE 2:
Now it’s 2014. The employers of both Lloyd and Floyd have now switched to withholding at the “married” levels.
Now Lloyd has $68 withheld each paycheck ($1,632 per year) and Floyd has $216 withheld each paycheck ($5,184 per year). Total withholding is $6,816.
Their gross income remains $72,000. Exemptions nudged up to $3,950 each = $7,900. The standard deduction for a married couple in 2014 is $12,400. Their taxable income is: $72,000 – $7,900 – $12,400 = $51,700. The tax owed on $51,700 by a married couple in 2014 is $6,851.
Since their withholding dropped by so much, they end up owing $35 dollars this time around: a swing of more than $3,200.
Note that their tax liability actually dropped slightly in 2014, but they still end up owing because of the big shift in withholding.
With some of my clients this year, the shift resulted in them owing thousands of dollars.
SOLUTION
Married people can elect to have their withholding come out at the single level, and that’s the best thing to do if a couple in a same-gender marriage finds themselves owing thousands of dollars at tax time.
In Lloyd and Floyd’s case, they could also choose to leave things as-is, as owing $35 means they nailed their withholding exactly right during the year … but that’s another topic for another day.