I often give this advice to married couples. It seems contradictory, but in the end, it may save you some headaches and an argument or two.
Meet a hypothetical couple, Alex and Jennifer. Two relatively high-income New Yorkers. They each earn about $150,000 for a combined income of $300,000. Alex and Jennifer were married last October and both upon arriving from their honeymoon, dutifully went to their HR departments and filled out new W4 forms and changed their statuses to “Married”. They had heard from a friend, that they should do this right away. A few weeks later, they were pleasantly surprised to see that their paychecks had increased by several hundred dollars. The benefits of marriage.
At tax time next year, they filled out their married tax return on TurboTax and were again happily surprised to see that they would receive a refund of $6,528. Being married surely was great for taxes!
Fast forward to the next tax filing season and Alex eagerly punched in their W2 information into TurboTax and waited for the good news. But something strange happened. Alex could not believe it. According to the TurboTax results, they owed $12,287! Alex rubbed his eyes, checked the figures again, but the result was the same. No refund this year. He had to pay the IRS! He interrupted Jennifer’s abs of steel workout and showed her the results. She was incredulous. Impossible! How could they go from receiving $6,000 to owing $12,000? They decided that there was a problem with the TurboTax results or that Alex had screwed up. So they did an internet search and located a local tax professional for help.
Alex and Jennifer met with the tax professional but were dismayed to find out the at the result was the same. What had gone wrong? As it turns out their mistake did not involve calculations. It was failing to seek professional help. A major life change – marriage, divorce, changing states, winning the lottery requires a little bit of professional help.
Jennifer and Alex were victims of the archaic and confusing tax laws. The tax professional explained to them that by incorrectly changing their tax withholdings ( Form W4 ) at work, they had inadvertently caused this problem.
A single person’s tax rate at an income of $150,000 is about 20%. A married family’s tax rate earning the same amount is about 15%. During the year that they were married ( single most of the year ), they paid approximately 24% in Federal Taxes each. Up until the point that they changed their W4’s they were in good shape. The year they married, they filed a joint return and their tax rate was little over 20%. Their combined withholding that year was over this amount and this is why they received a refund. The married tax tables seem to assume that only one spouse is working ( sort of like the 1950’s ) and therefore the lower tax rate and lower withholding amount. Generally, the W2 withholding on a married wage of $150,000 is about 14%.
Since Jennifer and Alex both changed their W4’s to Married Jointly, their combined current year withholdings were about 14% while their actual tax rate ( effective tax rate ) when filing their taxes will be higher. If the effective tax rate is 21% for example, then they are under paid by 7%. 7% of $300,000 is $21,000. That will hurt and generally causes a good deal of bad feelings at tax time.
For this reason, I strongly recommend that working newlywed couples leave their W4 settings as either Single or Married Filing Separately. Be Single at work but Married at home. This will help to maintain marital bliss.