Losing a spouse can be one of the most emotionally difficult events anyone can experience. To add insult to injury, one of the more repulsive parts of the tax code is something that is often referred to as the Widow’s Tax. Here is how it works.
IRS tax code treats married people very differently than single people. We have one set of tax rates for single people, and a separate set of rates for those that are married. Because of this, when a spouse dies, the surviving spouse will often face an increase in income taxes at the same time that their income actually declines.
Take a look at what happens in this hypothetical. Janet and her husband Steve retired ten years ago and are now both 75 years old. Steve worked as an electrician while Janet stayed home to raise their three children. After he retired, Steve begins to receive a monthly pension of $2,000 with a 100% survivorship benefit (meaning Janet will continue to get $2,000 a month when he passes). Steve also receives $2,000 per month in Social Security while Janet collects a $1,000 a month spousal benefit from Social Security.
They each have IRA accounts. In order satisfy their Required Minimum Distributions (RMDs) they’ve been taking withdrawals from them for a combined total of $25,000 a year. That adds up to $85,000 of gross annual income. We’ll assume they take the standard deduction, which is $15,100 for those over 65, married and filing jointly. They would also qualify for two personal exemptions worth $8,000 ($4,000 each).
On December 31st 2015, Steve passes away. Janet is completely devastated. She lost her best friend and the love of her life.
In addition to the tremendous emotional challenges she’ll face, here are some of the financial changes that Janet may not be expecting:
1) Social Security will decline: When both spouses are collecting Social Security and one passes, the surviving spouse generally receives the greater of their own benefit or their deceased spouse’s benefit. In our example, Steve was receiving $2,000 and Janet was receiving $1,000 for a combined monthly total of $3,000. She’ll choose Steve’s benefit because it is larger than hers. She will now receive $2,000 a month, which is a loss of income of $1,000.
2) She will be in a higher tax bracket: For a couple that is married filing jointly, the top of the 15% bracket is $75,000. For a single person, the top of the 15% tax bracket is $37,650. Therefore, as a single woman, more of her income will be subject to a higher tax bracket.
3) She will lose some deductions: Janet will lose the $4,000 personal exemption that Steve had. She’ll also now be subject to the single standard deduction of $7,850 rather than the $15,100 married filing jointly standard deduction.
4) A larger portion of her Social Security will be subject to taxes: The amount of Social Security that’s subject to taxes is calculated using a complex formula based on Adjusted Gross Income (AGI), 50% of Social Security benefits received, and the total of any tax-exempt interest received. Before Steve passed, roughly 70% of their Social Security was subject to taxes. Now that Janet is filing as single, 85% of her Social Security income will be subject to taxes because of her level of income.
So in our example, Janet’s actual income declined by $12,000 a year due to the reduction in Social Security benefits. Because of the factors mentioned above, her taxable income actually increases from $51,450 to $57,500. This results in her tax liability increasing from $6,799 to $10,146. So the tax per person increased from $3,399.50 a person to $10,146 a person.
*The personal exemption rose from $4,000 in for tax year 2015 to $4,050 in 2016
How the widow tax all adds up
While one could certainly argue that your expenses will likely decline when a spouse passes, there are also a number of major expenses such as housing that stay the same. Regardless of how many people live in your house, your mortgage or rent, taxes, utilities, and homeowners insurance don’t typically change much.
When a spouse passes, it is an extremely emotional and often frightening time. You’ve spent so much time with this other person and suddenly you have to reimagine and redesign what your life will be like without them.
With every couple, there’s a division of labor between the different responsibilities of the house, such as yard work, laundry, cooking, bill paying, budgeting, investing, and tax preparation. The surviving spouse will either have to take over some of these tasks or hire someone to do them at an additional cost.
Summary of our widow’s tax example
The additional taxes of $3,347 and loss of income of $12,000 reduces the total of Janet’s spendable income by a whopping $15,347 a year. Knowledge is power. Work with qualified professionals to develop a plan that can help you address any gaps that you may have. It probably won’t help with your grief, but it will almost certainly serve to reduce your stress and potentially prevent you from making some costly mistakes.