Reflections on Taxes

[FUEGO]

My federal and state income taxes worked out to be 17% of my AGI on a dual income 6 figure salary---minimal non-salary income. We max out our 401-k's, and HSA. Our house is nearly paid off (just three more months of payments to go), so really no interest to deduct at this point. I am amazed that someone with a 6 figure income could pay virtually 0 income taxes. I have no problem with people taking full advantage of the tax laws to minimize their tax bills, but even I, a pretty conservative Republican sort, think that ability to pay virtually no taxes at an income level like that is just wrong, inequitable, unfair. Not passing judgement on anyone who can do it, I am passing judgement on the tax lawas that make this possible.

I have to agree - there is no real equity here in the current system where I pay almost nothing but have an income over six figures.

Not that you are accusing me of this, but I just wanted to go on record saying I'm not doing anything sneaky, borderline illegal, questionable, etc regarding taxation. All of what I'm doing is standard stuff that most of us here do to some extent or the other.

I guess this is another reason why I'm not particularly concerned to make a lot more money. Most would go to the taxman.

 

[plex]

While a student in undergrad/grad school, I have usually gotten back $2-3.5k each year, usually 10-20% of what I earned in income. I essentially paid no federal taxes during this period, very little state tax, and was usually paid a net amount of $2-3k each year by the federal government. Got just about nothing back from the city tax I was charged at one point during a 3-month stint, but aside from that, "taxes" have actually resulted in income for me most years. I was surprised how much the state tax credit was for rent paid this year, about $400, which was about 60% of what I had paid in state taxes.

I remind my roommates each year to file taxes, even if they don't have jobs, but I am not even sure most of them do...

 

[kyounge1956]

I finished up the taxes this past weekend. (snip)

The federal tax burden was 0.4% of our total gross compensation (including deferred comp like 401k+match, profit sharing contribution, health insurance, etc). State tax was 4 times the federal tax. It is usually higher, but this year more than normal. The tax burden as a proportion of our cash compensation was 0.55% federal. (snip)

Yes, let's say for the sake of round numbers we had w-2 income of $100k and a federal tax liability of $550 (0.55% of salary plus benefits). (snip)

I don't know whether to be in awe, or infuriated! This is based on my 2008 taxes—I haven't filed for 2009 but not much has changed. I make less money (annual earnings with five digits, not six) but, figured the same way as you did—percent=tax paid/W-2 income—my income tax was a little more than 5%. That's over 10x as much, percentage wise, as you paid.

We do HSA, Child care FSA, max 401k, 2 Trad IRA's maxed out, foreign tax credits, child tax credit, plus Making work pay credit, and above the line deductible student loan interest. Our meager charitable contributions didn't matter since we don't pay nearly enough interest on our modest mortgage to itemize. State taxes were reduced by $350 due to 529 plan contributions.

I make too much to deduct TIRA contributions (so I have a Roth instead), but do max out my tax deferred plan at work, including over-50 catchup, and had over $13K of Schedule A deductions, but despite my significantly lower income, I paid five or six bucks of income tax for every dollar you paid.

I have to agree - there is no real equity here in the current system where I pay almost nothing but have an income over six figures.

What you said, double!

Not that you are accusing me of this, but I just wanted to go on record saying I'm not doing anything sneaky, borderline illegal, questionable, etc regarding taxation. All of what I'm doing is standard stuff that most of us here do to some extent or the other.(snip)

How do you do this again? I'm single & childless, so I'm ineligible for some of the deductions you take, but I would have thought my Schedule A deductions would have made up for that. Do you have your taxes done for you, use a computer program, or DIY? I've never thought it was worthwhile to pay someone to do mine, but if it could cut my liability even in half, never mind down to the level you pay, it would be worth it. What is this "standard" stuff you do that makes your taxes so much smaller a fraction of your earnings than mine??

 

[stephenandrew]

Not that you are accusing me of this, but I just wanted to go on record saying I'm not doing anything sneaky, borderline illegal, questionable, etc regarding taxation. All of what I'm doing is standard stuff that most of us here do to some extent or the other.

Thanks for recognizing the object of my irritation--it is certainly not you. What makes it all the more frustrating is that I have no doubt you are following all the rules and are legally able to effecitvely pay zero federal income tax. If I were in your shoes, I would be doing excatly the same thing. More power to you man!

 

[LOL!]

Suppose I earn $50K and my spouse earns $50K. Suppose we both put $22K each into retirement plans. We have 3 kids, one in college. Suppose we pay at least $10K in college tuition in order to get the AOC of $2500. Suppose we cashed in a 529 plan at a loss, so we get that tax deduction as well. Then we pay mortgage interest and property taxes. We also donate about $20K to charity each year. We also have health insurance premiums taken out of her paycheck before tax. We also have FSA money taken out of paycheck before tax and before FICA.

We do conversions of IRA to Roth IRA to fill up our 0% tax bracket and maybe some more. That IRA is from old 401(k) money that we didn't pay 33% tax on when we were working at jobs that paid a lot more.

Even without doing any math, you should be able to see that the tax liability has got to be close to zero. Don't forget 5 exemptions and 2 full child tax credits.

Now all we have to do is find money for expenses. That's not hard. We just use the 529 plan money that was sold at a loss. Or we sell some equities. There is no tax on return of capital and we have such a large capital-loss carryover that we won't be paying capital gains taxes for years to come.

There has to be a big pile of money in the background from a previous life or all this doesn't work. If that big pile of money is invested tax-efficiently, then there are only qualified dividends (taxed at 0% if your AGI is low income) and no bond income nor interest taxed at a higher rate. One also has to live a modest upper middle class lifestyle.

In essence the government is giving us a tax break so that our children do not become a burden to the government. You wouldn't want our kids stealing your hubcabs would you? You wouldn't want to be paying for their room and board for 5 to 20 years would you?

 

[ziggy29]

In essence the government is giving us a tax break so that our children do not become a burden to the government. You wouldn't want our kids stealing your hubcabs would you? You wouldn't want to be paying for their room and board for 5 to 20 years would you?

Well, at least in 20 years, I'll get my payback when they are writing my Social Security checks...

 

[LOL!]

Oh, I dunno. They may end up like their parents: retired early just 20 years out of college.

 

[FUEGO]

How do you do this again? I'm single & childless, so I'm ineligible for some of the deductions you take, but I would have thought my Schedule A deductions would have made up for that. Do you have your taxes done for you, use a computer program, or DIY? I've never thought it was worthwhile to pay someone to do mine, but if it could cut my liability even in half, never mind down to the level you pay, it would be worth it. What is this "standard" stuff you do that makes your taxes so much smaller a fraction of your earnings than mine??

I do my taxes myself. Excel spreadsheet and forms downloaded from the IRS (basically the computer version of pen and paper).

I think if I had an accountant prepare them, I would not understand the interaction of the various deductions, credits, etc. I make sure to read the "new for 2009" section and the "new for 2010" section from the 1040 instructions. It may take me roughly 8 hours or so now to do state and federal taxes including the reading of instructions. Luckily our taxes are greatly simplified now since we don't have college costs or the small business.

From what I posted earlier: "We do HSA, Child care FSA, max 401k, 2 Trad IRA's maxed out, foreign tax credits, child tax credit, plus Making work pay credit, and above the line deductible student loan interest. Our meager charitable contributions didn't matter since we don't pay nearly enough interest on our modest mortgage to itemize. State taxes were reduced by $350 due to 529 plan contributions."

HSA = $5950 deduction
FSA = $5000 deduction
401k = $28,000 deduction
2 Traditional IRA's = $10,000 deduction
Medical, dental ins comes out pretax = $1000 deduction
Standard deduction w/ Real estate tax $1000 added = $12,400 deduction
Personal exemptions x4 = $14,600 deduction
Capital loss carryover = $3000 deduction
Student loan interest = $2100 deduction (above the line)

Foreign tax credit = ~$300 credit (hold most international in taxable account)
Child tax credit = $2000 credit
Making work pay credit = $800

In summary, roughly $82,000 in deductions from total income, plus $3100 in tax credits. If we had made about $4000 less income, we would have actually received a paycheck back from the government in the form of a refundable tax credit. Obviously one must be able to contribute at least $44000 to tax deferred plans to be able to replicate my results. Having two spouses working certainly helps.

Also, I had a few thousand in qualified dividends, and that was taxed at 0%.

 

[CuppaJoe]

I w*rked on my taxes a bit this morning, realized I’m not at w*rk, went back to bed thinking, “it’s not rocket science and not due yet.” The itemizing is done, just a matter of adding it all up and plugging in the numbers; no rush since nothing was withheld for the first time ever, that’s something to love about being retired.

 

[kyounge1956]

I do my taxes myself. (snip)
From what I posted earlier: "We do HSA, Child care FSA, max 401k, 2 Trad IRA's maxed out, foreign tax credits, child tax credit, plus Making work pay credit, and above the line deductible student loan interest. Our meager charitable contributions didn't matter since we don't pay nearly enough interest on our modest mortgage to itemize. State taxes were reduced by $350 due to 529 plan contributions."

HSA = $5950 deduction As things now stand, I'm not eligible for an HSA because I don't have a high deductible health policy. I don't know if one is available through my job or, if it is, whether I'd actually save money overall. Maybe after retirement?
FSA = $5000 deduction I could have an FSA through my job, but at this time my medical expenses are so low—generally only a few small co-payments per year, no prescription meds or chronic conditions—that I don't use one. If I knew I was going to need new glasses I might use an FSA that year only. As long as I'm working, my dental care is 100% covered, but I plan to pay out of pocket for dentistry after retirement. I don't know whether I'm eligible to contribute to FSA when not employed & need to find out.
401k = $28,000 deduction $22,000 for me
2 Traditional IRA's = $10,000 deduction I'm not eligible for this one...I don't meet the income limits & am covered by a pension plan at work. But my contributions to the pension fund come out of my pay before taxes. That, plus my transit pass, which is also paid with pre-tax money, come to about $6K/year
Medical, dental ins comes out pretax = $1000 deduction So do mine, but I probably pay less than $1000 a year
Standard deduction w/ Real estate tax $1000 added = $12,400 deduction >$13K of Schedule A deductions
Personal exemptions x4 = $14,600 deduction I only get one
Capital loss carryover = $3000 deduction N/A—I don't have a taxable investment account
Student loan interest = $2100 deduction (above the line) N/A—I only had one small student loan, and paid it off years ago

All told, my W-2 says about 38% of my pay is excluded from my taxable wages, and I itemize about another 18%, for a total not taxed of 56%. More of your income is excluded, but you said you don't itemize. Are we about comparable here?

Foreign tax credit = ~$300 credit (hold most international in taxable account) N/A. But please explain. Did you get a credit because you paid this $300 in taxes to some gov't other than the US, or do you get a reduction of U.S. taxes whether you paid foreign taxes or not?
Child tax credit = $2000 credit I'm ineligible—no kids
Making work pay credit = $800 What's this?

In summary, roughly $82,000 in deductions from total income, plus $3100 in tax credits. If we had made about $4000 less income, we would have actually received a paycheck back from the government in the form of a refundable tax credit. Obviously one must be able to contribute at least $44000 to tax deferred plans to be able to replicate my results. Having two spouses working certainly helps.

ISTM the tax credits are what are making the big difference, but I'm not eligible for the largest of these, the child tax credit.

Also, I had a few thousand in qualified dividends, and that was taxed at 0%.

I don't have any dividend income that I know of, and if I did it's inside my tax-deferred plan and will be "ordinary" income when I withdraw it, regardless of what sort of income it started off as. Maybe I should be putting some of the money that's now going into my tax advantaged accounts into taxable investments instead....it seems like there are some tax advantages to that which might complement the tax advantages that I get from my 457 plan & Roth IRA.

 

[FUEGO]

All told, my W-2 says about 38% of my pay is excluded from my taxable wages, and I itemize about another 18%, for a total not taxed of 56%. More of your income is excluded, but you said you don't itemize. Are we about comparable here?

Very close on the % excluded from taxable wages. We are lower than you on the "standard deduction as a percentage of total".

ISTM the tax credits are what are making the big difference, but I'm not eligible for the largest of these, the child tax credit.

Yes; the tax credits take what would otherwise be a few thousand in tax liability and make it less than a thousand.

You should be eligible for the Making Work Pay tax credit. $400 per person. File schedule M on the 1040. This is a new one this year, and easy to miss. It's near the end on the Form 1040.

I don't have any dividend income that I know of, and if I did it's inside my tax-deferred plan and will be "ordinary" income when I withdraw it, regardless of what sort of income it started off as. Maybe I should be putting some of the money that's now going into my tax advantaged accounts into taxable investments instead....it seems like there are some tax advantages to that which might complement the tax advantages that I get from my 457 plan & Roth IRA.

Not sure about the pros/cons of keeping some money in taxable accounts versus maxing tax deferred accounts. Make a spreadsheet and do the math is the best answer I have at this point. I haven't done the math recently for me.

There is certainly something appealing to letting a tax efficient investment spin off dividends each year that are taxed at 0% for me as a low tax bracket taxpayer. Then they get reinvested, hence increasing the tax basis for my investment. Eventually when I sell, the Cap Gains will get preferential tax treatment too (currently 0% federal for my 15% ordinary income bracket). This versus getting a tax deduction now with 401k/Trad IRA in exchange for paying ordinary income taxes at the time of withdrawal. I could see some instances where it may be beneficial to not contribute to an IRA or 401k and keep things taxable.

In a taxable account you also have the benefit of taking the foreign tax credit for the taxes that your international investments pay. And in a taxable account, you could tax loss harvest the losers, providing an additional $3000 annual deduction from income.

For me, I'm paying a 7% marginal tax rate on all income, dividend, capital gains, etc. So the benefits of 0% fed tax rates (which may expire) on divs and CG's are a little blunted.

 

[Kabekew]

Well everybody here pats themselves on the back for paying little in taxes. And you all know the big corporations also pay relatively little in tax because of the nature of C corporations and carrying over losses, writeoffs, etc.

So who ends up paying for all this spending? SMALL BUSINESS, that's who. The largest group of employers in our country. But we don't have a unified voice or lobby so we're the easiest to quietly slam with the tax shortfall. My last year in business I took home less than $100K, I live in a modest townhome, drove a modest gas-saving car, and yet I had to pay $800,000 in taxes! That's six new highly-paid professional jobs I could have added to the community just that year alone. Small businesses that are pass-through LLC's get no credit for reinvesting profits back in the business or hiring more people. So why bother? The government takes it anyway.

My attitude rapidly became F- that, F- my state, F my city and their stupid business taxes, F it all. I dissolved the business and sold out my assets instead of growing it and providing more jobs.

Small business is the lifeblood of our economy and we're squeezing them to death because there's nobody left to pay for our out-of-control spending. Keep that in mind when you all congratulate yourselves on how little taxes you pay, because SOMEBODY's paying it instead, and I don't think it's the handful of the filthy rich, and I don't think it's the big corporations.

(End of rant! )

 

[ziggy29]

Well everybody here pats themselves on the back for paying little in taxes. And you all know the big corporations also pay relatively little in tax because of the nature of C corporations and carrying over losses, writeoffs, etc.

So who ends up paying for all this spending? SMALL BUSINESS, that's who. The largest group of employers in our country. But we don't have a unified voice or lobby so we're the easiest to quietly slam with the tax shortfall. My last year in business I took home less than $100K, I live in a modest townhome, drove a modest gas-saving car, and yet I had to pay $800,000 in taxes! That's six new highly-paid professional jobs I could have added to the community just that year alone. Small businesses that are pass-through LLC's get no credit for reinvesting profits back in the business or hiring more people. So why bother? The government takes it anyway.

I guess all I'd say is that I distinguish between opinion of policy and opinion of the people who take advantage of that policy.

I think it stinks that someone can earn six figures and pay zero or close to zero in federal income tax. I think it's an outrage. Having said that, as long as what they did is completely legal and above-board, I can't blame them. Heck, I respect and admire their resourcefulness. I'd do the exact same thing in their situation.

Yet at the same time it infuriates me that two people earning the same amount of money -- let's just say two households earning $100K each -- can pay drastically different amounts in tax based on how they configured their lives. One may pay almost zero and another $15,000 or more. IMO, that's wrong, but the outrage is most properly directed at the laws and the folks who keep carving out these loopholes, deductions and exceptions -- not toward the people who take all the deductions to which they are legally entitled.

 

[bank5]

I guess this is another reason why I'm not particularly concerned to make a lot more money. Most would go to the taxman.

I'm not sure I understand the reasoning. Say you made an additional $50,000. Wouldn't a small amount (not most) go to the taxman?

I wonder if the word "taxes" has as much of a negative connotation in other countries.

 

[45th Birthday]

This is a subject that has bothered me a great deal, but believe me I'm not going to do anything to put myself in a position to pay more. I was a small business owner who for years paid lots and lots in taxes. Now, I don't. For 2008 (2009 not finished, but will not look much different):

Income $411,271
Federal Tax -$1,150 (refundable credit)
State Tax $8,046
FICA, Medicare $2,435

How does this work? The income includes only a small salary and lots of muni bond income. It also includes a lot of option premium income, which gets taxed like capital gains. Since I harvested a huge amount of losses, this is "tax free" and will remain so for several more years. Then, I will start paying taxes again. There is also a good amount of qualified dividend income.

I have high deductions for things like interest and taxes. I could have actually earned more without paying more taxes at the federal level. The state tax rate in my state is pretty low, but includes taxes on muni bond income.

Setting this up was an process that evolved over a few years as I realized how the numbers worked and after doing lots of TurboTax what-ifs.

Everything I'm doing is totally legit. I should pay more, but I don't have to. So should many others. Our tax system is broken.

 

[FUEGO]

I'm not sure I understand the reasoning. Say you made an additional $50,000. Wouldn't a small amount (not most) go to the taxman?

I wonder if the word "taxes" has as much of a negative connotation in other countries.

We are pretty close to being in the 25% bracket for 2010 given a couple different things this year versus 2009. That gives us a marginal rate of around 40%. Add in some phase outs of deductions/credits, and the marginal rate will jump. Maybe to 50%. Add to that the change from zero tax rate on dividends in my current 15% bracket to 15% tax on dividends in the 25% bracket.

I'm just in that sweet spot of not paying a lot of taxes despite high income. I make much more and some of the good deal I have now goes away. Not that I'm opposed to making more money, just hard to get motivated when I would only keep half roughly.

 

[haha]

It also includes a lot of option premium income, which gets taxed like capital gains. Since I harvested a huge amount of losses, this is "tax free" and will remain so for several more years. Then, I will start paying taxes again.

This is a common way to keep taxes low- run a losing investment program. Keep at it, your taxes will (rightly) stay low.

Ha

 

[haha]

We are pretty close to being in the 25% bracket for 2010 given a couple different things this year versus 2009. That gives us a marginal rate of around 40%.

I do not understand your meaning here. If you are in the 25% bracket, your marginal rate is 25%. That is what is meant by being in the 25% bracket. Or do you mean that your federal marginal rate is 25%, and the state 15%, making them together equal 40% not allowing for offsets?

Ha

 

[FUEGO]

I do not understand your meaning here. If you are in the 25% bracket, your marginal rate is 25%. That is what is meant by being in the 25% bracket. Or do you mean that your federal marginal rate is 25%, and the state 15%, making them together equal 40% not allowing for offsets?

Fed 25%, State 7%-8%, SS/Medicare 7.65%. Roughly 40% marginal rate before factoring in phase outs at the state and fed level.

 

[bank5]

We are pretty close to being in the 25% bracket for 2010 given a couple different things this year versus 2009. That gives us a marginal rate of around 40%. Add in some phase outs of deductions/credits, and the marginal rate will jump. Maybe to 50%. Add to that the change from zero tax rate on dividends in my current 15% bracket to 15% tax on dividends in the 25% bracket.

I'm just in that sweet spot of not paying a lot of taxes despite high income. I make much more and some of the good deal I have now goes away. Not that I'm opposed to making more money, just hard to get motivated when I would only keep half roughly.

You are in a nice sweet spot. But say you win a $10,000 scratch card. Would you not cash in because you'd have to pay half in taxes?

 

[45th Birthday]

This is a common way to keep taxes low- run a losing investment program. Keep at it, your taxes will (rightly) stay low.

Ha

Well, I don't know anyone invested in equities when the bottom fell out who didn't have some losses. Unless you keep all your money under the mattress, you will be exposed to nasty moves in the market. The solution: sell near the bottom, replace with like things immediately or wait 30 days to replace with exacts. Same economic position, but with a tax cushion. Nice way to make lemonade out of lemons.

During 2008, I beat the S & P 500 by 6.8%. During 2009, by 5.2%. YMMV.

 

[FUEGO]

You are in a nice sweet spot. But say you win a $10,000 scratch card. Would you not cash in because you'd have to pay half in taxes?

No doubt I would spend the few minutes to take it to the gas station or the downtown lottery office to cash it and gladly pay tax on it.

But in a not so hypothetical situation for me, let's say I could take a job paying $60,000 more. It would be a lot more stressful, require significantly more than 40 hours per week, and would require hard work during most of those hours, including learning a new field of practice. It would also likely require a fair amount of non-reimbursed non-deductible expenses that I don't have now (rather long commute, wardrobe, dry cleaning, etc).

I have chosen not to pursue this more stressful course of action. That is what I mean when I say I'm not particularly concerned about earning a lot more money. In other words, I'm not willing to work a lot harder when a majority or very large minority of my additional earnings will be confiscated by the taxmen.

 

[bank5]

^^^
So taxes play a role in the cost-benefit analysis but it isn't the main role. The main factor would be the amount of additional work and time the promotion would require.

 

[ziggy29]

You are in a nice sweet spot. But say you win a $10,000 scratch card. Would you not cash in because you'd have to pay half in taxes?

There's a big difference between willingly paying 50% in taxes on lottery or gambling winnings (actually, for me it would be 25% as this is not earned income, taxed at my marginal rate and there's no state income tax) and paying 50% on $10,000 of overtime work or a second job.

I'll gladly accept $10,000 in "free money" that's taxed at 50%. I'm much less likely to work longer hours for an extra $10,000 that's taxed at 50%.

 

[FUEGO]

^^^
So taxes play a role in the cost-benefit analysis but it isn't the main role. The main factor would be the amount of additional work and time the promotion would require.

If you want to phrase it in the cost-benefit analysis format, here it is. The cost is a significant increase in my labor effort and time plus unreimbursed expenses noted (rather long commute, wardrobe, dry cleaning). Implicit in the cost is loss of most of my free time (most of my weekday evenings, and 1/2 of my weekend). The benefit is the pay I would receive net of taxes.

So per this analysis, you are correct, the taxes are not the "main role", since no individual consideration serves a "main role" in the cost benefit analysis. But the taxes are what tips the scale against the decision to pursue this course of action. If the "benefits" were greater (ie if I could move the taxes mostly back onto the benefits side of the scale), my decision would be different.

For example, say the disutility of working significantly more plus unreimbursed additional expenses are a $40,000 cost to me, and the benefits of net pay after taxes are $30,000 (half of my $60,000 gross pay). Costs exceed benefits, hence I would not pursue. Say taxes were cut in half (to 1/4 my gross pay increase of $60,000), and my costs remain $40,000. My benefits of net pay after tax would be $45,000, hence I would receive a $5,000 net benefit by pursuing the new opportunity.

And I can also read the writing on the wall. I'm pretty sure I would quickly become "rich" and subject to even higher taxation as a member of the elite rich class.

So, meh, not interested! I'm ok being the no-tax-paying millionaire next door.