Monthly Archives: June 2017

Newlywed Tax Consequences to Avoid

shutterstock-340594079The wedding was beautiful, the honeymoon unforgettable, and your new life together is off to an amazing start. However, there was no discussion concerning the tax consequences of being married; the need to change your filing status; or adjust your withholding allowances from your paychecks.

The marital status is determined as of the last day of the year. Regardless of whether you were married on New Year’s Day or on New Year’s Eve your filing status options are married filing joint or married filing separately. Many newlyweds wait until after they are married to change their tax withholding status at their jobs. This may be fine depending on how much each spouse earns, but it is the first step to realizing a much bigger problem. A problem that can lead to a rather large tax bill come April 15th of the year after you were married.

The tax forms and even some publications will tell the married couple that they are now allowed an additional exemption and a higher standard deduction. They should adjust their withholding allowances, change their tax filing status, and have fewer taxes deducted from their paycheck. What you are not being told is that the additional exemption should not be claimed if both spouses are working. In addition, the standard deduction used in the withholding tables also only considers one spouse working. Just because you are now married does not mean you will pay less taxes.

A common mistake is that each spouse informs their employer that they are now married and completes a new W-4 (Withholding Allowance Certificate). They both claim married and some will even compound the problem further by claiming two exemptions each. The tax tables and tax rates are based on the taxable income of a joint couple.  Even if you are choosing to file Married Filing Separately, the tax brackets are one half of the Married Filing Joint tax brackets, and you will rarely see any savings using this status.

Tax brackets are a range of incomes taxed at a given rate. The more you make, the higher tax bracket you are in. This does not mean that all of you income is taxed at the higher bracket; it means your tax bracket only determines the amount your income tax increases if you earn one additional dollar. This is where the trouble starts. For a married couple the first $18,650 of taxable income is taxed at 10%. The rates progressively go up with the next $57,249 of taxable income being taxed at 15% and increasing at different intervals all the way to 39.6% when taxable income exceeds $470,700.

If both husband and wife were earning approximately the same income and they both claimed Married with one exemption, they would both be taking advantage of the lower 10% bracket. For example, a husband wife are both earning $75,000 and claim Married with one exemption.  The withholdings from their paychecks would each take advantage of the joint standard deduction and consider their first $18,650 of income being taxed at 10%. What the couple has failed to realize is that they now make $150,000 and some of their income will be taxed at the 25% bracket. With higher earnings by the Newlyweds, the problem can be compounded.

Let’s compare the real numbers based on the example above. The couple earning together $150,000 takes a standard deduction in 2017 of $12,700 and personal exemptions of $4,050 each for a taxable income of $129,200 and a tax of $23,778. If they never completed new W-4 forms after they got married, they each would each have withholdings as a single taxpayers based on $64,600 of taxable income or $11,889 of tax. Jointly the amount would be $23,778 or the amount of their tax liability. However if as of the beginning of the year, they completed a new W-4 claiming Married with one exemption. The total withholdings would only be $7,805 each or $15,610 jointly. Come April 15th, they would owe over $8,000 to the IRS, and the Newlywed Tax Nightmare would begin. The example provided gets increasingly worse the higher the joint income.

The W-4 has a withholding status of Single, Married, or Married, but withhold at the high single rate. The third option is included to prevent the problem described above. After the Honeymoon is over and you are back to work take caution in completing a new Form W-4 and don’t fall into the tax trap which so often ends the Newlywed phase of a marriage.

John Rosenberger, CPA, CGMA

Scholarship’s Affect on 529 Plan Withdrawals

Many parents establish 529 college savings accounts to cover some or all of their children’s college education costs. Distributions from a 529 account used for qualified education expenses are tax and penalty free if the amount distributed is equal to or less than the designated beneficiary’s (child’s) qualified education expenses during the same year.piggy-bank-booksj

For distributions that exceed the child’s qualified education expenses, the earning’s portion of the distribution may be subject to tax as well as an additional 10% penalty. One of the exceptions to this 10% penalty that is rarely discussed is scholarships.

This exception allows you to withdraw up to the amount of your child’s scholarships from the 529 account without paying the 10% penalty on the earnings, even if you don’t use the money for eligible college costs. To qualify for this exception it is suggested that you take the distribution in the same year the scholarship is received. You still have to pay taxes on the earnings withdrawn if they’re not used to pay for eligible college costs just no 10% penalty.

So if your child receives scholarships during his or her college years and you find yourself having excess monies in the 529 account as a result of the scholarships, you can withdraw it and use it for other purposes and avoid the 10% penalty.