Taxpayer marital status and the QBI deduction.

AuthorMasselli, John J.

The law known as the Tax Cuts and Jobs Act (TCJA), (1) enacted in 2017, made significant changes to the corporate and individual tax structures. Corporate tax rates were reduced from a maximum rate of 35% to a flat rate of 21%, the corporate alternative minimum tax (AMT) and the domestic production activities deduction were eliminated, and provisions were enacted to shift the U.S. corporate tax structure from a worldwide tax system to more of a territorial system.

Individual tax rates were lowered, with the top rate falling from 39.6% to 37%, standard deductions and child credits increased, and personal exemptions eliminated. Some additional limitations were imposed on itemized deductions, including on qualified residential interest and state and local tax deductions. Some charitable contribution limitations were relaxed, while miscellaneous itemized deductions (including unreimbursed employee business expenses and investment expenses) were eliminated altogether.

In addition, to ensure equity and parity for U.S. businesses taxed as conduit entities (e.g., sole proprietorship, S corporations, limited liability companies, and limited/general partnerships), Congress created Sec. 199A, which provides for a 20% qualified business income (QBI) deduction. This provision was enacted in direct response to the corporate tax rate reduction from 35% to 21%. Simply stated, the QBI deduction serves to potentially reduce a conduit entity's effective tax rate from 37% to 29.6%. Unlike the corporate tax rate reduction (which is permanent), the QBI deduction, along with the majority of TCJA-enacted individual tax modifications, is scheduled to sunset on Dec. 31, 2025.

Concurrent with any major tax reform is consideration of how it impacts marriage penalties/bonuses. A marriage penalty or bonus is the difference in a couple's total tax liability resulting from a change in filing status from single or head of household to married filing jointly (MFJ).The extent of such a penalty or benefit is a function of various factors, such as the amount of combined income and how it is earned (e.g., approximately evenly between spouses or significantly disparately), the credits to which the taxpayers are eligible, and whether the couple are subject to the AMT, net investment income tax, and/or the additional Medicare tax.

Amir El-Sibaie (2) argues that marriage penalties and bonuses violate neutrality and that analyses show that marriage penalties/bonuses tend to have little to no effect on whether a couple will marry. More recently, however, Christine Cheng et al., (3) analyzing a sample of 43,587 same-sex couples from the 2012-2016 American Community Survey (ACS) Public Use Microdata Sample, found that an impending marriage tax penalty did, in fact, have an economically significant effect on a same-sex couple's decision to marry, while a marriage bonus did not have a corresponding impact. The study provides evidence that same-sex couples may weigh tax and financial considerations differently in rendering their decision to marry, as compared with opposite-sex couples. That said, the U.S. Census Bureau (4) indicated that, as of 2019, an extensive number of opposite-sex, cohabitating couples (about 8 million, or approximately 11.5% of the number of all opposite-sex couple households--a figure that has increased in the last decade) had opted to forgo legal marriage, suggesting that this subgroup of the population may also elevate consideration of tax/financial factors in their marriage decisions.

Other researchers examined the TCJA's impact on marriage penalties/bonuses and found that various aspects of the TCJA attempted to equalize the tax burden between the single and MFJ filing statuses, but other provisions, such as more restrictive limitations on certain deductions, ultimately had the opposite impact. (5)

Existing research, however, does not include an examination of Sec. 199A through the lens of the marriage penalty/bonus. On the surface, Sec. 199A appears relatively immune to marriage penalties/bonuses, in large part because the income ceilings under which a full QBI deduction is allowed are logically paired (i.e., $163,300 for single taxpayers versus $326,600 for MFJ (2020 limits)). A deeper investigation reveals this is not the case and that the QBI deduction may significantly affect marriage bonuses/penalties. (6)

One might ask whether tax planning strategies linked to a decision to marry are moot, given that a 1997 Congressional Budget Office study, (7) using data from 1969 to 1995, finds that marriage penalties/bonuses have little effect on whether a couple will marry. The answer is no, for two reasons. First, the 1997 study did not analyze same-sex couples, who were granted the legal right to marry only in 2015, (8) and who Cheng et al. (9) found do consider factors such as marriage penalties in their marital decisions. Second is the upward trend in the number of opposite-sex couples opting to forgo legal marriage, likely for a host of reasons that include tax/financial considerations. More specifically, Robin Fisher et al., (10) Mike Schneider, (11) and the U.S. Census Bureau (12) found in their 2018, 2020, and 2021 studies that the number of same-sex joint filers is estimated to be about 58% to 59% of the total number of self-reported same-sex couples, while the same ratio for different-sex couples is 88.5% to 92%.

Interestingly, the percentage of unmarried same-sex couples has remained quite constant since marriage equality was granted by the Supreme Court in Obergefell v. Hodges (13) in 2015, while the percentage of unmarried opposite-sex couples is on the rise, going from 8% to 11.5% in the latter part of the last decade. Overall, the data suggests that approximately 8.4 million unmarried couples are in the United States (i.e., 412,000 same-sex (14) and 8 million opposite-sex (15)).

This article discusses a series of hypothetical tax scenarios designed to highlight the potential marriage bonuses or penalties that may be associated with Sec. 199A. It first briefly discusses the QBI deduction, with an explanation of key provisions of Sec. 199A, and then gives an overview of the TCJA's impact on marriage penalties/bonuses.

Business taxation in the US as justification for Sec. 199A

For federal taxation purposes, U.S. businesses fall primarily into two categories:

(1) conduit (disregarded or passthrough entities--e.g., sole proprietorships, partnerships, and S corporations) and (2) C corporations. Most businesses in the United States are taxed as conduit, or passthrough, entities, as evidenced by the most recent data published by the IRS Statistics of Income (SOI) division for years 1980-2015. (16) The data indicates that in 2015, approximately 92.5% of all business returns were filed by passthrough entities, while only 4.6% were by C corporations. In terms of business net income for 2015, the disparity was not as extreme as the number of the returns filed but is still significant, in that conduit entity business net income was approximately 63.3% of the total, compared with 36.7% for C corporations. The significant prevalence of single-taxed conduit entities in 2015 is logical, given the maximum potential federal tax rate of 39.6%, compared with double-taxed C corporations, with a maximum combined federal tax rate of 50.47% (35% + 15.47% ([qualifying dividend tax rate of 20% + the net investment income tax rate of 3.8% = 23.8%] x 65% (i.e., available earnings and profits = corporate net income less federal income taxes at 35%))). (17)

Over the last 113 years, federal corporate tax rates have fluctuated from a low of 1% in 1909 to an all-time high of 52.8% in 1969 (to fund the Vietnam War). From 1993 to 2017, the top corporate tax rate remained stable at 35% for corporations with taxable income over $18.33 million. (18) Individual tax rates have experienced similar variability. From 1987 to 2017, top individual marginal rates dropped to a low of 28% for tax years 1988-1990 to a high of 39.6% before enactment of the TCJA. (19) In 2017, the TCJA permanently reduced the corporate tax to a flat rate of 21%, effective for tax years 2018 and after.

A key element of the TCJA was congressional focus on lowering business tax rates as a vehicle to expand the tax base while incentivizing job creation. During the congressional debate over the TCJA, conduit entity owners sought comparable tax relief. (20) Heeding this request, in no small part because...

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