A "singular" tax penalty

FORGET THE MARRIAGE PENALTY. Fact is, singles get a worse break from the tax code than marrieds do. Worse yet, sometimes you can be treated as a single even if you are married.

Here are some of the most egregious problems singles face.

Bracket Benefits. Rates for single taxpayers are higher than those for marrieds, whether you file jointly or married filing separately. For example, for 2004, on a taxable income of $100,000, a single has a marginal tax rate of 28% and pays a tax of $22,627. Compare that to a married taxpayer with a spouse who has no income. Now the marginal tax rate on that $100,000 drops to 25% and the total tax dips to $18,475.

Let's be fair, though. If both husband and wife work, they probably will pay a higher total tax than if they filed as single. That is the traditional marriage penalty. Sometimes, however, it works in reverse, especially when one spouse has little or no income. The wider the disparity, the higher the tax on the single taxpayer.

Estate Escapes. In addition to income tax, which imposes a levy on income, there is estate tax. That is a separate fee on the transfer of wealth at death. The transfer of wealth during life is subject to a gift tax. Between income, gift, and estate taxes, the IRS has got you coming, going, and gone.

Yet, there is a special benefit in the estate and gift tax arena--the marital deduction. It means that any transfers to a spouse, during life or at death, escape tax. Since this only exempts transfers to a spouse, if you are single, you again get disproportionately slammed.

Employee Benefits. Here is where we have to be real careful. Your number one employee benefit is health insurance. It almost always is available to an employee's spouse. Moreover, without fail, it is going to be tax free to the employee and the traditional spouse. Not so for unmarried couples. While many companies voluntarily are providing "spousal" medical and dental benefits to domestic partners, their tax-free nature depends on whether the partner is a dependent of the employee. If so, there is no tax. If not, the employee is taxed on the fair market value of the excess payment, as additional wages. That means more payroll as well as more income tax for you to pay.

To qualify a partner as a dependent, and get tax-free status, you have to pass four tests:

* Provide more than half the support of the person you are claiming as a dependent. Support is what is spent, not just what is earned or available.

* The person supported must be a specified relative or member of your household. The IRS has decreed that the relationship of the member of your household can not violate local law. However, rely laws currently on the books against certain types of intercourse or making cohabitation a crime are constitutionally suspect.

* Generally, the dependent cannot file a joint return.

* The dependent must be a U.S. citizen, or a resident of the U.S., Canada, or Mexico.

If you want an exemption for the dependent, you will have to meet a fifth criteria--the gross income test. Subject to exceptions, the dependent cannot have a gross income in excess of the personal exemption amount, which is $3,100 for 2004. You do not need to pass the gross income test to qualify as a dependent.

Retirement Restrictions. When I die, my wife will inherit my 401(k) and individual retirement accounts. She will roll the money into her own IRA and avoid paying any tax until she later retires and takes out the dollars. Singles, who do not have a qualifying "'surviving spouse," do not have that option. Their IRA beneficiaries can spread withdrawals over their lifetimes, but, they do not get the right to delay the scan of distributions.

With a 401(k), it can get even stickier. Many companies do not want the responsibility of making lifetime distributions to unmarried beneficiaries. They will require the beneficiary take the money all at once. That eliminates any deferral and probably pushes the beneficiary into a higher tax bracket.

Child Care Credit. The Child Tax Credit of as much as $1,000 per child phases out if adjusted gross income exceeds $110,000 on a joint return. Single parents, even filing as Head of Household, start to lose their credits as income exceeds only $75,000. Singles are shortchanged again.

Social Security Survivors. When I die, my wife will have a choice. She can retain her own Social Security benefits, or accept mine, whichever is greater. If we were just living together, as a couple, she would not have that option. Unmarried couples are not eligible for survivor's benefits. Once again, singles get the short stick. Here's an example where life insurance on the life of the higher earner may be useful to refill the cash flow gap at death.

Miscellaneous Issues. Unmarried couples also face uncaring inheritance laws. They have no rights outside a will. Without one, even the most distant relatives have priority over a deceased partner's property.

Get your will updated! On May 18, the first legal same sex marriage was performed in Massachusetts. Federal law, however, still defines spouse as a person of the opposite sex. That means that married gays will not qualify for Social Security survivor or family leave benefits. They do not get the marital deduction for gift or estate purposes and cannot file jointly. Benefits should be taxed based on the same "dependent" analysis, although I have yet to see anything directly on point from the IRS.