Economists in love: Is marriage worth the extra tax bill?

Marriage not worth the taxes to these folks.

Two young economists, Justin Wolfers and Betsy Stevenson,  who met and fell in love in Harvard's PhD program, said no to marriage because of the taxes.

Three decades earlier, my husband and I were also economists in love at Harvard, and we reached the opposite conclusion.

Justin and Betsey explain their reasoning in an excerpt from an interview on the Spouseonomics blog:

Justin: Because Betsey and I earn similar incomes, we would pay a marriage penalty.  The U.S. has a household-based taxation system which subsidizes married families when one person stays home and taxes most people extra if they choose to marry and both work full-time.  The average tax cost of marriage for a dual-income couple is $1,500 annually.  When our accountant ran the numbers for us a few years back we discovered marriage would cost us substantially more.  I love Betsey and all, but is the marriage certificate worth thousands of dollars annually?  I can love her plenty without the certificate.  But this isn’t just about a bean-counter saving his beans.  Truth is, I find it offensive that the tax man treats me differently according to a  very private decision—whether I marry or not.  And so I prefer to remain unmarried, at least in the eyes of the tax man.  And I would also be more sympathetic to the formal legal institution of marriage if it were open to all couples, not just straight couples.

Betsey: It’s not all taxes and politics.  It’s also contracts.  Marriage is a contract between two people about how to organize their lives together.  But modern marriage is a one-size-fits-all contract—a default written by the state legislatures.  It makes no sense to me that I would want to sign the same contract with Justin that you sign with your partner.  So we didn’t take the standard off-the-shelf contract that we call marriage.  Instead, we’ve talked at length about what is important to each of us, and it’s that Betsey-and-Justin-specific agreement that guides our lives together.  And as anyone who has studied divorce knows,  the formal marriage contract doesn’t actually bind our future selves. But I have something far more enduring with Justin than a wedding certificate: We have an amazing daughter, who will bind us together for, well, until death do us part.

You can read more about them in today's New York Times.

Over three decades ago, my husband and I, like Justin and Betsey, also met and fell in love in Harvard's economics PhD program.

The marriage penalty we faced when we married in 1979 was greater in percentage terms than today's academic economists would generally face. (It is easy to use the National Bureau of Economic Research's handy on-line tool, TaxSim, to get a quick estimate of marriage penalties in every year from 1960 to the present. And no--you don't have to be a card-carrying economist to use it. It is available for anyone to use.)

We said "I do" to marriage --- and the resulting tax bill!

I just used TaxSim to calculate our hypothetical tax bills at the beginning of marriage and academic careers in 1979. Our federal income taxes based on tax law at that time as a married couple were over 22% higher than they would have been if we had gone the Stevenson-Wolfers route.

Had we remained legally single, we would have paid a total of less than $24,000 in federal income tax, but marriage resulted in a tax bill of over $29,000. (All numbers are based on 1979 tax law, but expressed in current 2012 dollars, using the Bureau of Labor Statistics CPI calculator.)

Tax rates were higher on everyone back then and getting married pushed us newly minted assistant professors from the 34% marginal tax bracket to the 43% marginal tax bracket.  Our effective *average* federal income tax rates went from 19% of our AGI to 23% when we married as newly minted assistant professors of economics earning identical salaries.

We got married anyway (the photo above is from our wedding dinner, held at a Szechuan restaurant across the street from the White House on Pennsylvania Avenue--we had a simple and inexpensive but memorable and meaningful ceremony and celebration with just a few friends and family members, less than 20 people were there in total, no special wedding gown for me or tux for my husband, but beautiful hand-dyed batik napkins for the wedding dinner that my mother created from old bedsheets, which we still use on special occasions! The restaurant said they couldn't provide a cake, but we were welcome to bring our own, so my mother baked one herself.  When we asked the waiter for a knife to cut the cake, they brought the only type of knife they had in the restaurant--a butcher's cleaver!  A little unusual, but it still worked fine!)  We look forward to celebrating our 33rd anniversary this summer.

I just asked my husband to be sure he still agrees--we have no regrets!

Of course, the marriage penalty varies according to income and other circumstances (e.g., children, deductions, etc.) and some people actually get a marriage bonus rather than a marriage penalty.  As Justin points out, two-earner couples with relatively equal earnings tend to face a marriage penalty, while couples in which one spouse earns much less than the other tend to get a marriage bonus.  Over the course of a lifetime, many couples may have years when one spouse earns significantly more than the other or vice versa, due to health issues, disability, taking care of children or elderly relatives, as well as years when both spouses have roughly equal earnings.  The Tax Policy Center has an excellent overview of the topic, including a good bibliography to launch further investigations available here.

In percentage terms, the steepest marriage penalties today are actually NOT those faced by high-earning power couples like Justin and Betsey, folks who have the luxury of choices and the money to hire lawyers to make suitable substitute arrangements for marriage, not to mention that they also have a nanny (with a master's degree in education, whom they pay $50,000 per year) as well as a housekeeper and chauffeur (whose credentials and salary were not reported in the New York Times.)

The steepest marriage penalties are those faced by many low-income working single parents, much greater than those my husband and I faced or those that Betsey and Justin faced.   This may explain why we see very few married couples filing returns at our site.   A glance at the Earned Income Tax Credit graph and a little arithmetic make the reason for this immediately evident.  Two unmarried single parents earning minimum wage and working fulltime receive the maximum amount of EITC.  If they marry, they will wind up receiving little or no EITC.

The Tax Policy Center provides more details about the huge marriage penalties many of the working poor face here.   Of course, the marriage penalties for traditional welfare (AFDC) were even greater than those in the income tax code.

Justin also raises concerns that the federal government does not recognize same-sex marriages.  I agree with him that this is wrong, and I am glad to be able to say that this year, New York State is finally treating all married couples identically thanks to the Marriage Equality Act.  It does introduce some complications for our VITA site, because we need to prepare separate returns (Single and/or HoH filing status) at the federal level and then a Married Filing Joint return at the state level based on a hypothetical but not actually filed federal joint return, but it is worth it to us to treat our clients with equal dignity and respect for their status, at least at the state level.

I also agree with Justin and Betsey that there are many inequities in the tax laws treating married and unmarried couples.  European countries address this problem by doing away with joint returns altogether and requiring all individuals to file separate returns, regardless of marital status.   However, such a move in the United States is complicated by the fact that the US has community property rules for attributing income in some states but not others, as well as the issue of how to deal with refundable credits aimed at low-income households.

Happy Valentine's Day to all, married and single, straight and gay.

If you filed early and your refund is later than expected,

it is probably NOT about you!  It is probably NOT about your preparer either.

Paid preparers are getting an unusual number of complaints about delayed refunds from this year's early filers.  I have heard stories of unhappy taxpayers demanding their W-2s back and wanting to take them elsewhere to efile, only to learn that it is too late to go elsewhere after the original efile has been accepted by the IRS.

It is frustrating for early filers when they hear from friends who filed later that they have already gotten their refunds.  Rent is due today and it may be hard for their landlord to believe them that they are waiting on a refund that was supposed to arrive today, if another tenant has already gotten his refund and paid his rent.

We are getting reports of problems from early filers at VITA sites also.

Here is what I am telling our taxpayers:

The IRS has modernized its efile system. 

The good news is that our IRS acknowledgements accepting our efiles are coming back in record time, generally within an hour of submission, thanks to the new modernized efile process (MeF)!  Even our New York State acknowledgements are coming back sooner than before (generally in less than a day), despite the fact that New York State is still on "Legacy efile."

More good news:  the IRS has implemented new security procedures to cut down on the growing serious problems of tax fraud and identity theft.

Not so good news:  these new security procedures had some early glitches that need to be ironed out.  The IRS is reporting that returns efiled in the first week of the filing season (1/17 to 1/24) may take up to a week longer to process than predicted.  Many taxpayers with direct deposit refunds, who were accustomed to receiving them within 10 to 15 days, may need to wait an extra week.

More not so good news:  Some taxpayers are getting alarming reports on Where's my refund? for those early efiles.  In some cases, Where's my Refund? is telling them that their efiled direct deposit refunds may take up to six weeks, rather than the originally predicted 10 to 15 days.  I am guessing that this is a projected "worst case scenario" that the IRS is using to manage expectations from taxpayers.  I hope (and pray!) that those refunds will arrive long before six weeks.

The problem is that the overwhelming majority of past taxpayers are used to receiving their refunds on schedule, with the IRS machinery running like clockwork.  There were notable exceptions, especially when Congress acted at the last minute on late December tax law updates, but we were usually able to explain and anticipate these for taxpayers.

This year, we have no clue why so many taxpayers with simple, straightforward, and clearly NONfraudulent returns are finding their refunds held up in processing with no clear answers.

All I can say to you is that it is NOT about you, the overwhelmingly honest and compliant majority of taxpayers.  It is also NOT about all the honest professional tax preparers and VITA sites out there.

Unfortunately, there is a tiny number of fraudulent filers that are screwing up the process for everyone, and the IRS is doing its best to weed them out to preserve the integrity of the system for those who are honest.

Also unfortunately, that is holding up the process for many people, most of whom are completely innocent of fraud.  Because the system is new, it is taking more time than originally expected.

It is also hard to explain why some people are stuck in fraud filters, and others are not.  I can say that it is happening to many taxpayers and preparers around the country who are completely honest and straightforward on their tax returns.

The IRS has put out an official statement saying that it regrets the inconvenience to taxpayers.

I am here to add to that statement, because I think more needs to be said, and I know that the folks at the IRS are too busy working on the problem to say it.

I recognize that for many of you, a delayed refund does not just mean "inconvenience."  Inconvenience is a word that may apply to the middle class and others well above the poverty line.

The right word for many of our clients is not "inconvenience," but "increased hardship."

I understand, and I am sorry.  

Please stay in touch--I want to hear from you.  Please let me know when your refund comes in.  And if it is delayed more than 10 days since you last checked in with me, please let me know.

Many of our VITA site early filing clients were already suffering hardship when they came into file early.  Many are struggling with unemployment, disabilities, health problems, and other difficulties.  They are worried about keeping the heat on in their homes, the landlord at bay, the car from being repossessed, paying the copays for the prescription drugs they need.  For many VITA site clients, their refund means the difference between living below the poverty line and above it.

I am deeply sorry for the increased hardship, uncertainty, and confusion for all the honest early taxpayers all over the country who are waiting in uncertainty.

I know that the folks at the IRS are also sorry, and are working as hard as they possibly can to make things right for you.

Could Mitt Romney pass the VITA Intermediate level test?

After reading recent coverage in the New York Times, I have my doubts.  Taxes on self-employment income are a required topic for the Intermediate VITA exam.    All Intermediate level preparers know that self-employed unincorporated small business owners are required to pay the full payroll tax on their net business earnings on a Schedule SE.

On  Jan 21 the New York Times reported this response from Gov. Romney to a New York farmer complaining about the fact that he--as a self-employed business owner--was required to pay the full payroll tax (employee and employer share) on his business income:

“And with regards to the payroll tax, I’ll take a look at that,” [Romney] said. “I didn’t realize you’re paying that additional — that double taxation — and that’s worth taking a look.”

A few days later, Mr. Romney released his own tax returns and the NYT reported:

Mr. Romney learned to his surprise that self-employed people pay what is essentially both the employer and the employee’s share of their payroll tax obligation.  “I’ll take a look at that,” he told a small businessman who “bird-dogged” him in New Hampshire. But it turns out that he needs to look no further than his own tax return. Mr. Romney paid self-employment tax on this income — both halves of it. The total came to $29,151.

Here is Mr. Romney's 2010 Schedule SE (clicking on the image will enlarge it so you can read it more clearly):

Mitt Romney's Schedule 2010 SE payroll taxes were a tiny percentage of his income, less than 0.2% of his Adjusted Gross Income, and a relatively insignificant part of his total tax bill of $3 million that year. Apparently this is such a minor matter for him that he had not paid much attention to it at the time he signed his tax return underneath the statement: "Under penalty of perjury, I have examined this return and accompanying schedules and statements, and to the best of my knowledge, they are true, correct, and complete."

But for most working Americans, payroll taxes loom large as the biggest single tax they pay.  And--if we use standard and widely accepted CBO incidence methodology--this remains true whether they are self-employed or whether they are working for an employer who remits payroll taxes on their behalf.    Using standard CBO incidence methodology, a typical working American whose income consisted entirely of wages and/or self-employment income totalling less than $106,800 paid about 15% of his income in payroll taxes in 2010 and about 13% of his income in payroll taxes in 2011.

Mitt paid a far lower percentage (less than 0.2% of his 2010 income) for two reasons:

1) Big reason:  the lion's share of his income was not subject to payroll taxation, because it was classified as "investment income" rather than "earned income."
2) Secondary reason:  his actual "earned income" of roughly half a million dollars (from speaking fees and directorship fees) greatly exceeded the Social Security wage cap of $106,800, so most of it was only taxed at 2.9%, rather than the 15.3% rate that applies to income below that cap.

In any case, Governor Romney, since you have promised to "look into" the issue of self-employment taxes for small business, here is a good place to start:  the VITA lesson on how to prepare simple small business tax returns.

Tax season 2012 in upstate New York

Cows down the road from us from two days ago

Not much snow yet this season.

There's a farm down the road from our house.  In over two decades of living here, we have never seen the cows out in January before!   That's because there is usually far too much snow cover for them to graze outdoors.  Normally they disappear inside the barn by early December and do not reappear again until June, by which time new grass has reestablished strong enough roots to stand up against their trampling.  So we have never seen cows during tax season before.  My husband was sufficiently surprised to see the cows out in late January that he shot the photo above.

So it was funny to see today's Google doodle:

Today's Google doodle!

However, snow does not deter the hardy buffalo from grazing.  See here and here.

Warren Buffett's secretary does NOT have to make $30,000 to pay a higher effective average federal tax rate than he does!

My very distinguished former colleague, Professor Paul Gregory of the University of Houston, believes that  Warren Buffett's secretary probably makes $200,000 to $500,000 in salary in order for Warren Buffett's claim to be true that she pays a higher average effective federal tax rate than he does.

More unadulterated nonsense!

VITA sites serve taxpayers with incomes under $50,000 and we see many taxpayers who pay more than 20% of their incomes in federal income and payroll taxes.

$20,000 in pay would make Buffett correct!

Yes, taxpayers with young children often pay much less than that and retired taxpayers pay much less than that, but working taxpayers who do not have young children living with them pay much higher rates.   With all due respect, Warren Buffett's secretary looks like she is past the age where she is likely to have young children living at home.

Warren Buffett clearly stated that his claim was about the total amount of federal income and payroll taxes paid on his income compared to that paid on his employees' income.

Warren Buffett has stated that his Adjusted Gross Income was $62,855,038 in 2010, producing an income tax liability of $6,923,494 and a payroll tax bill of $15,300.  That adds up to an effective average combined tax rate 11% of his adjusted gross income.

Of course, privacy rules do not allow me to discuss the tax situations of the particular individual real life individual taxpayers who use our VITA site.  But I can say that VITA sites like ours see many taxpayers with incomes in the $20,000 to $50,000 range who pay more than 11% in combined federal income and payroll taxes.

Let's take the very first case study in the VITA workbook, Rose Hudson.  (The picture below comes from the IRS website.)  Rose is hypothetical but very representative of the single most common type of taxpayer we see at a VITA site, a single taxpayer with no dependents, with income primarily from wages reported on a W-2.

Rose Hudson:  AGI $32,000 combined effective federal tax rate 24% of AGI

Rose is a waitress, with wages and tips of $31,915 last year.  She also earned $36 in savings accounting interest.  Using standard Congressional Budget Office (CBO) assumptions about the incidence of payroll taxation, which assumes that both portions of the Social Security tax burden fall on the employee, the payroll tax bill was $4,873.  Rose's income tax liability was $2,946.  Adding those two figures together gives us an average effective federal combined tax rate of 24% of AGI.

Of course, we could quibble about the denominators.  When Warren Buffett originally stated his effective tax rate, he quoted 17% for his own tax rate, which used taxable income as the denominator rather than AGI.   If we use the same denominator of taxable income for Rose's effective average tax rate, we get 35% for her!

Ideally, we would actually use a much broader measure of income than either AGI or taxable income, the Haig-Simons definition of income.  For Rose, her Haig-Simons income might include some tax-free fringe benefits.  Warren probably gets some of those as well, but he likely has an even bigger component of Haig-Simons income which is missing from his AGI, namely his UNrealized capital gains.

Anyway you slice it, a secretary or waitress earning a modest amount of income ($30,000 or so), pays a much larger combined effective federal tax rate than Warren Buffett does, unless she lives with "qualifying children".

Union College VITA team 2012

This year's Union College VITA students have set new standards of excellence.  All have passed both the basic and intermediate level IRS certification exam for VITA preparers in record-breaking time.   This is the first time ever that 100% of our students were intermediate level certified one full week before our VITA site officially opens.  All of them have also completed the core economics classes in intermediate microeconomics and econometrics.  Collectively, they bring a great deal of energy and a wonderful diversity of talents, interests, backgrounds, and perspectives to our service-learning class in tax policy and practice this year.    

First row in photo:

Katie Manko, senior majoring in Asian studies and economics, from Winchester, Massachusetts.

Yohanny Vargas, senior majoring in managerial economics, with a minor in anthropology, from Brooklyn, New York.  Yohanny's campus leadership roles include serving as president of Union's economics club as well as leading the Circulo Estudiantil Latino Americano (CELA).    She has interned at Merrill Lynch's Private Wealth Management division.  For more about Yohanny, see here.

Brian Karimi, senior majoring in economics and philosophy, from Hingham, Massachusetts.  Brian is on the editorial staff of Union's student newspaper, Corcordiensis.  His articles can be read here.

Lawrence Hung, senior majoring in economics, from Queens, New York.

Yiran Zhang, senior majoring in managerial economics, from Suzhou, China.

Dandan Zhang, junior majoring in arts, from China.

(Yiran and Dandan continue a wonderful tradition of Union VITA students from China, launched by Christina Yu Chen in 2009.)

Second row in photo:

Sam Solomon-O'Connell, junior majoring in managerial economics, from Suffern, in Rockland County, New York.  Sam spent the fall term on Union's term abroad in Belgium.

David Sorensen, junior majoring in economics, from Mount Kisco, New York.  David is the latest in a long dynasty of great members of the Union College swimming team to be part of our VITA program, starting with Ashley Braniecki in 2008, followed by Sarah Yergeau in 2010, and Andrea Marois in 2011.

Matt Petrone, junior majoring in economics, from Utica, New York.   Matt is a member of Union's basketball team, continuing a great tradition of excellence in juggling the demands of the basketball season and tax return preparation started by Lauren McCormick two years ago.

Habib Kamara, junior majoring in managerial economics, from Poughkeepsie, New York.

Colin Knox, junior majoring in economics.

Jigme Norbu, sophomore planning a double major in math and economics, with a minor in Japanese.  Jigme is from the Himalayan kingdom of Bhutan.

Jacob Berman, a senior majoring in psychology, from Scarsdale, in Westchester County, New York.

And the prize for "least helpful error diagnostic message" goes to:

The screenshot above is the entire TaxWise error message for New York State efile error code 0911.   How reading the word "Reserved" is supposed to help me "find and fix errors" is beyond me.

Our VITA site submitted six efiled tax returns late Thursday night/early Friday morning.  They went to the IRS as "Modernized e-file" (MeF for short) and to New York State as "Legacy" (the euphemism for "not yet modernized.)

The IRS promptly accepted and acknowledged all six returns, within a few minutes of submission.  Yay! The federal refunds are working their way through the system.  Direct deposits should go to taxpayer bank accounts in less than two weeks.  Paper checks to those taxpayers who requested them should go out about a week after the direct deposit date.

New York acknowledgements came through about 36 hours after submission.  New York State accepted two of the returns and rejected four returns, all with the mysteriously inscrutable "error code 0911."    

This is unprecedented.  We have never had more than a very occasional or isolated reject in the past, certainly never two-thirds of the returns!  Indeed, we typically go weeks without getting rejects and then--once in a blue moon--we get one.

And on the rare past occasions where we have gotten rejects, there has been a clear explanation of the error code.  The most common cause of past rejects is that another taxpayer had already--wrongly--claimed the same dependent on his/her return that our client had rightfully claimed.  If the wrongful claimaint beats the rightful claimant in the race to efile, the rightful claimant is forced to paper-file the return, and eventually the IRS sorts it all out.

In the case of the 0911 efile coded rejects received today, I am sure that dependents are not the issue, since some of the rejected returns did not have even claim any dependents, and moreover all of the returns in question had already sailed through the IRS.  (New York State does not even track the SSNs of dependents on its returns, so it apparently relies on the IRS to catch double-claimed dependents.)

After checking with the TaxWise user discussion boards, I found reports from several other sites getting the same message.

Update:  I found a very helpful link to a complete set of NYS reject explanations online here.   That PDF on the NYS Tax Department website contains a much more helpful explanation of the 0911 error code (screenshot below) than TaxWise shows in its error screen (screenshot above):

What I believe is happening is that when the preparer clicks the button to "Deposit the NYS refund to the same bank account where the federal refund was deposited," TaxWise is somehow not transmitting that bank account information in a way that the New York State tax department computers can understand.

TaxWise reports that they are "aware of the problem and working on it," according to a user message posted on the TaxWise discussion boards.  My guess is that there is an easy fix for the problem.

It is a bit ironic, though, because New York State is really trying to push taxpayers to get their refunds by direct deposit these days, and yet the returns that requested a paper check sailed through through the acceptance process, while the returns requesting direct deposit were held up.

Still, I feel reasonably confident that the problem will be resolved quickly and taxpayers who requested their refunds via direct deposit will still get them sooner than those who requested a paper check.