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When Two Equals Two, Not One

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Many marriage ceremonies include language about two individuals becoming one. Some may consider this concept largely symbolic, but the United States tax code is dead serious on the point.

Married couples can choose whether to file their income tax returns separately or jointly, but most couples file together unless they have specific reasons for doing otherwise. Even if they file separately, tax brackets are different for married people who choose to file separately than for single people. Also, those couples who file their returns as married filing separately are barred from claiming various deductions and tax credits available to single taxpayers. In some tax situations, marriage is a benefit; in others, it can be a penalty.

A recent federal appeals court ruling has emphasized one of the tax drawbacks married couples currently face. Larry Elkin wrote about the original decision in this space a few years ago. The case concerned an unmarried couple, Dr. Charles Sophy and Bruce Voss. Sophy and Voss had a domestic partnership, and jointly owned two residences in California. As separate taxpayers, Sophy and Voss each deducted interest payments on the $1.1 million of mortgage debt that the law allows for unmarried taxpayers.

However, back in 2009, the Internal Revenue Service announced that the deductible debt limits were meant to apply “per residence,” not per taxpayer. The IRS informed Sophy and Voss that the agency was disallowing part of their deductions, made prior to 2009, as a result. In 2012, a tax court judge upheld the IRS’ position.

The U.S. Court of Appeals for the Ninth Circuit reversed that ruling earlier this month in a split decision. The court stated that the text of the statute, as written, applies the debt limit provisions on a per-taxpayer basis. The majority’s argument was that Congress’ presumed intentions are not enough to override the language that actually appears in the law. Much of the argument hinged on the fact that if Congress wanted to make the statute clearer regarding the fact that the limitation applied on a per-residence basis, it would have done so. Therefore, the lower courts and the IRS could not rewrite the law on Congress’ behalf.

Unless reversed by the Supreme Court, a prospect not on the near-term horizon, the Ninth Circuit ruling is binding in nine western states and two Pacific Island territories. It is not clear whether the IRS and Tax Court will honor or challenge that ruling in other parts of the country, where other appellate panels could conceivably decide the matter differently.

The logic underlying the original tax court ruling relied on the judge’s claim that the language used to establish the deduction limits was unclear, and thus subject to interpretation by the agency and the courts; the appellate panel found that the statutory language is not ambiguous after all.

The appeals court is probably right in its interpretation of the law, but that doesn’t mean the law as written won’t continue to cause problems. For one, the court acknowledged that the law as it currently operates creates a marriage penalty. However, it overcame this point by acknowledging that married couples face marriage penalties in other areas of the tax code, suggesting that there is no compelling reason for the court to rewrite the statute to eliminate it in this case.

In some ways, this ruling has given couples with large mortgages an incentive not to get married, since single taxpayers double their collective mortgage interest deduction limit. High-income earners generally face the largest marriage penalty, because the tax brackets at the upper end of the income scale for married couples aren’t exactly double those for single taxpayers. Such individuals are also those who would most likely have mortgages large enough for this decision to matter.

Personally, I would never recommend forgoing marriage just for the tax consequences. Marriage, like having children or moving to a new state, is a huge decision that affects much more than your tax situation. But for unmarried couples with large mortgages, this court decision gives them one more factor to consider.

The number of ways in which responsibility for a mortgage payment may be split raises a variety of questions about the tax law as it stands. What would happen, for instance, if four unmarried roommates decided to buy a property together with a $5 million mortgage? Would they get to deduct mortgage interest on up to $1.1 million in mortgage debt each - $4.4 million total? Now, let’s assume the roommates decide to pair up and marry one another. Would the amount of mortgage interest they get to deduct suddenly be limited to $1.1 million of mortgage debt per couple ($2.2 million total)? Based on this decision, presumably yes to both scenarios. In the scenario where the roommates decide to marry, they lose the opportunity to deduct interest on $2.2 million of mortgage debt - thus being penalized for marrying.

If lawmakers didn’t really mean what they wrote, they may amend the law, especially now that the Supreme Court has removed the limbo same-sex couples occupied in states that recognized their marriages while the federal government still refused to do so. It seems likely that the “per-residence” basis, now struck down, was an ad hoc attempt to reconcile Congress’ failure to address cohabiting individuals and same-sex couples when the statute was originally drafted. Unless and until lawmakers change the law, the effective marriage penalty now affects same-sex and opposite-sex couples alike.

The appeals court decision recognizes the reality of the law as Congress wrote it, whatever lawmakers’ actual intentions. Now that the courts have spoken, the mortgage deduction will remain one area where those who haven’t tied the knot stand to benefit.

Client Service Manager ReKeithen Miller, who is based in our Atlanta office, is the author of Chapter 14, “State Income Taxes,” in our firm’s book, Looking Ahead: Life, Family, Wealth and Business After 55.

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