ourapproachWidows are obviously faced with a period of grieving, sadness and remembrance.  However, when that first new tax bill comes in, they are going to get ticked off.  Most financial professionals have heard of the marriage penalty, but the widow’s penalty is even more inequitable.

Here’s an example of the marriage penalty: the 3.8% surtax on net investment income kicks in at $200,000 of MAGI for single taxpayers, but married couples filing a joint return don’t get a $400,000 MAGI threshold. Instead, they have a $250,000 MAGI threshold, just $50,000 more than a single filer’s threshold. As a result, two single filers each with $200,000 of net investment income will not be subject to the 3.8% surtax, but if they were to get married, they would have $150,000 of net investment income subject to the surtax. The resulting $5,700 surtax owed ($150,000 x 3.8% = $5,700) would be considered a “marriage penalty”, OUCH!

Eventually a widow will become “single filing” status taxpayers. Single filers move into higher tax brackets more rapidly. For example, take a retired couple with $60,000 of taxable income. That puts them in the 15% federal tax bracket. However, if one spouse dies in 2013, the surviving spouse will file as a single person in 2014. Assuming no major decreases and income, that surviving spouse is now in the 25% tax bracket. A 67% increase in her marginal tax bracket. OUCH again!

The tax code is infested with stealth widow penalties.  Here are some examples:

  • Higher marginal and effective tax rates, or the same marginal rate but a higher effective rate
  • Single filing taxpayers move into higher tax brackets more rapidly than married couples filing a joint return
  • More of a surviving spouse’s Social Security benefits may be taxable
  • Personal exemptions and itemized deductions phase-outs may increase
  • More investment income may become subject to the new 3.8% surtax
  • A surviving spouse may be more likely to get hit with the AMT
  • Medicare part B premiums may increase
  • RMDs could be higher if an IRA is left to an older surviving spouse, and therefore, higher income tax
  • Deductions, such as those for medical expenses, may be lower

Pension income is usually built with a joint and survivor option.  Required minimum distributions still continue.  Investment income usually remains the same.  In some cases, investment income can increase if the surviving spouse was left with life insurance proceed.  Bottom line, in our experience, income may not decrease as much as clients think.  But, stealth taxes appear out of nowhere.

Death of a loved one is hard enough, the dark forces of a crazy complicated tax code, in this case, is unreasonable. The only good news is that with some planning, the impact may be minimized.

Special thanks Marty James, CPA, a charter member of Ed Slott’s Master Elite IRA Advisor Group. Both Marty and Ed Slott and Co. have done a superb job researching this issue. Their arti

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