Reflections on Taxes

[bank5]

^
The decision is easy for a job that you aren't going to like. But would you ever turn down a raise where your job stays completely the same because of tax reasons?

 

[ziggy29]

The decision is easy for a job that you aren't going to like. But would you ever turn down a raise where your job stays completely the same because of tax reasons?

If the job remains exactly the same -- same duties, same responsibilities, same hours -- then accepting the raise is *exactly* like accepting a winning lottery ticket in the amount of the raise or bonus! Of course it makes no sense to turn it down when you don't have to work longer or harder to get the extra money -- regardless of the tax rate on that windfall.

Now if I had to take a second job to get the extra money, or if the "raise" came with longer hours and/or increased responsibilities and stresses, I just might turn it down. In fact, in my current situation I almost certainly would decline it; I want more free time and less stress a lot more than I want a little more money.

 

[Danmar]

This is very interesting. I read a tax study recently that said the US gets a higher percentage of its tax revenue from wealthy individuals than most other OECD countries. This is despite the fact max marginal tax rates are lower in the US than most other countries. This issue seems to be the many deductions that are allowed. The strangest to Canadians is mortgage deductibility. Makes absolutely no sense. Not hard to see why your gov't can't balance its budget. Much fewer deductions allowed in Canada. I paid about 30% combined fed/provincial tax in 2008. This would not be atypical I think.

 

[haha]

Not hard to see why your gov't can't balance its budget. Much fewer deductions allowed in Canada. I paid about 30% combined fed/provincial tax in 2008. This would not be atypical I think.

I agree about mortgage interest deduction. Want a housing bubble? Among other strategies, it always helps to make mortgage interest deductible. But realtors and the mortgage industry are big political contributors, and that is all that matters.

On your combined 30%, is that your marginal rate, or the overall bite? In other words, if you earned $100,000, did you pay $30,000 to those two entities?

Ha

 

[Danmar]

30% is average rate. Max marginal rate is 39%. Difference is low marginal rates at the bottom incomes and some deductions (mostly alimony).

 

[Gone4Good]

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.

Remember that income subject to SS taxes is capped at $106,800. So you're really looking at more like a ~32% marginal rate.

 

[Gone4Good]

This is very interesting. I read a tax study recently that said the US gets a higher percentage of its tax revenue from wealthy individuals than most other OECD countries.

Greater income inequality in the US also plays a part.

 

[Shawn]

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%.

Yes, work doesn't pay. This is a problem with our tax system (IMO). Tax authorities operate exactly the opposite of businesses that have profit motives.

For example, many businesses offer their employees perks for working overtime. Someone normally earning $20/hr might get $30/hr for working the weekend or perhaps $40/hr for working a holiday. Businesses do this for a reason. They believe that the extra productivity is worth the additional cost. Employees do it for the same reason. As a teenager at McDonald's, I got time and a half when working more than 8 hours a day. These were gladly accepted opportunities.

The tax system is exactly the opposite. Effectively, the tax system offers people less for working more. An employee who normally earns $20/hr gets only $12/hr for working overtime. While the employee receives more money, it is at a rate significantly less than their normal salary. The incentive to perform additional work is greatly reduced.

The tax system does not encourage productivity. My effective tax rate is 34.6% and my marginal tax rate is 43.5%. The benefits of work (e.g., money) are being overshadowed by the costs (e.g., stress). This encourages me to early retire. While this may be good for me, it is not good for the government. When I retire, the $60K/yr in total taxes that I currently pay to the government will drop to less than $10K/yr. The government is encouraging me to work less and give them less money.

 

[Letj]

You are welcome. According to de gubbermint i don't work for a living - all that rental income is unearned income. Means i don't pay into social security, which is cool, but also means i will collect pocket change for SS at some point. Also means no IRA. The interest income is taxed at regular income rates. We are kid-free and unmarried. Last year I spent 17.1% of my AGI on Federal taxes and 7.4% of AGI on state taxes. At least we don't have sales tax here, but property tax on our home cost a couple percentage points of AGI. So maybe 26.5% of my AGI goes to providing infrastructure, police and fire protection, offering cash inducements to Afghan poppy farmers, and as much government as i can stand or afford.

Maybe the lesson here is that I should have more cash in stocks busily increasing in value but not throwing off profit. If convinced that stocks made more money i guess i would... Just too chicken to count on Mr. Market to provide for me.

Do you use a schedule C or schedule E? I started out using schedule E but it became too burdensome to do a schedule E for each property so I am changing it this year. I have the properties owned under three single member LLC so this year I plan to use schedule C for each LLC.

 

[Danmar]

Greater income inequality in the US also plays a part.

agree. When I was younger and trying to increase my net worth, I always thought the lower taxes in the US would be great. Now that I have "overcome" Canada's high tax environment (at least to some extent), I have changed my thinking. Canada's more generous social safety net encourages a more egalitarian society I think. This in turn encourages less crime and probably improves quality of life given a set level of wealth. So in summary-earn it in the US and spend it in Canada.

 

[FUEGO]

^
The decision is easy for a job that you aren't going to like. But would you ever turn down a raise where your job stays completely the same because of tax reasons?

No; it takes me roughly a fraction of a second to say "yes" in response to a raise. Even if they taxed it at 99% I would still take it, assuming it comes with literally zero additional responsibility.

However in my experience in my line of work, you get COLA+1-2% if you are making normal progress in a career. You get your professional license at 4 years into it, and you get a bump. After that, you are stagnant (well, maybe COLA+1-2%) unless you progress into increasingly more responsible roles (project management, departmental management, rainmaking, etc).

And I would definitely switch jobs to what I think would be a big pay raise, assuming the new job had a similar set of requirements in terms of stress, hours, environment, etc.

 

[FUEGO]

Remember that income subject to SS taxes is capped at $106,800. So you're really looking at more like a ~32% marginal rate.

33.45%. Medicare doesn't go away at the threshold I don't believe, but SS does. And with a $50,000 raise, all my income, I would be right at the cusp of not paying SS tax on a marginal basis. That's a little odd too in that once you cross that threshold your marginal rate actually drops.

 

[Gone4Good]

The tax system does not encourage productivity. My effective tax rate is 34.6% and my marginal tax rate is 43.5%. The benefits of work (e.g., money) are being overshadowed by the costs (e.g., stress). This encourages me to early retire.

I doubt you'd feel differently if your marginal rate was 33% or 23%. What I suspect you're really feeling is the diminishing marginal utility of money. People are very motivated to earn their first $20K because they're worried about things like food and shelter. After their 5th $20K they have the luxury to start worrying about trade offs like "stress". At some point, for some of us at least, more money isn't worth the time it takes to earn it. There isn't a marginal rate low enough to fix that for most of the people on this forum.

 

[Shawn]

I doubt you'd feel differently if your marginal rate was 33% or 23%. What I suspect you're really feeling is the diminishing marginal utility of money. People are very motivated to earn their first $20K because they're worried about things like food and shelter. After their 5th $20K they have the luxury to start worrying about trade offs like "stress". At some point, for some of us at least, more money isn't worth the time it takes to earn it. There isn't a marginal rate low enough to fix that for most of the people on this forum.

Perhaps. But there are many reasons to (early) retire. The marginal utility of wealth is certainly one of them. However, marginal gains or the lack of are also very important.

I imagine many people here would postpone their retirement by some length of time if their employer told them that their salary would "double" during that remaining time. In fact, I find myself considering various options. Do I retire on December 31, the last day that my marginal tax rate is reduced by 6.2% (since I'm above the SS threshold), or do I work an extra 3 months and retire on March 31 because those 3 months will have a lower tax rate (since I'll have no earned income the remaining 9 months).

There are several other factors all associated with marginal gains (cash out of unused vacation time, the advantage of Roth conversions using after-tax contributions, computation of social security). A difference of only a few thousand dollars is causing me to consider retirement date adjustments of several months. So yes, if my marginal (or effective) tax rate was reduced by 10-20% it would have a significant impact on retirement decisions. It doesn't mean I'd work forever, but it would mean an extra $20-40K a year in after-tax dollars. I'd take advantage of it. The reverse is also true. If my effective tax rate suddenly increased from 34.6% to 50%, I'd be out the door tomorrow.

 

[kumquat]

33.45%.

Really, a few years ago, here in Canuckistan, my marginal rate was 52%. Now, the top rate, is down to about 43%. YAHOO!

Since my income is from investments, I can't choose to work less (or can I work fewer than zero hours per year?)

 

[FUEGO]

Really, a few years ago, here in Canuckistan, my marginal rate was 52%. Now, the top rate, is down to about 43%. YAHOO!

Since my income is from investments, I can't choose to work less (or can I work fewer than zero hours per year?)

Is that 43% top rate inclusive of local/state/provincial taxes or merely federal taxes?

My 33.45% rate occurs just after earned income for one person surpasses $106,800. Less earned income than that, and my marginal rate is 40%. Right now, the top total marginal rate in my state (incl federal tax) on earned income is roughly 44.5%. Proposed tax law changes may make this 49%.

And all of the marginal rates I'm talking about don't include the effect of deductions and credits that get phased out as your income increases. Or the impact of the Alternative Minimum Tax. So my 33.45% marginal rate is most likely significantly higher than that. It is so complicated to really figure it out and understand how everything works together that I am not sure how to determine the actual marginal rate.

 

[oneils]

... Much fewer deductions allowed in Canada. I paid about 30% combined fed/provincial tax in 2008. This would not be atypical I think.

Very similar to my situation. My effective tax rate (I'm in Ontario) was 27% for 2009. This does not include my property taxes. I made about 80K gross.

edit - this is a very interesting thread!

 

[smjsl]

Based on a tax return I recently came across, I remembered this thread and decided to play with some numbers. For a single retiree over 65 years old, a typical tax scenario for Federal taxes in a "simple" traditional IRA-withdrawal case might be along the following lines...

$12k/year Social Security, $20k/year traditional IRA withdrawal, no other income.

Results: taxable social security income: $500
AGI: $20500 (20k IRA withdrawal + taxable social security income above)
Standard deduction $7100 + additional deduction $3650
Taxable Income: $9750
Federal taxes: $1045
Effective federal tax rate: $1045 / $32000 ~ 3.3%

The (effective) tax rate is of course quite a bit larger than what FUEGO pays at over $100k income...

Question: what's their marginal rate? If you guessed 15%, you are actually wrong...

For every additional dollar of income, $0.50 more of social security is taxed, so real marginal rate is 22.5%

If retiree wanted to stay in 10%-bracket, i.e. to ensure that both bracket is smaller and none of Social Security benefits are taxed, they could withdraw maximum of $19,000 in above scenario, resulting in

AGI: 19000 (19000 + 0 taxable social security)
...
Federal taxes: $825
Effective federal tax rate of $825 / $31000 ~ 2.7%
Marginal federal tax rate: 10%

Effective tax rate is still quite a bit larger than OP...

What's a poor retiree to do?

 

[LOL!]

What's a poor retiree to do?

Have some kids late in life.

It probably wouldn't hurt to get new younger spouse to go along with the kids.

And if the spouse works, that's even better.

 

[FIREd]

Based on a tax return I recently came across, I remembered this thread and decided to play with some numbers. For a single retiree over 65 years old, a typical tax scenario for Federal taxes in a "simple" traditional IRA-withdrawal case might be along the following lines...

$12k/year Social Security, $20k/year traditional IRA withdrawal, no other income.

Results: taxable social security income: $500
AGI: $20500 (20k IRA withdrawal + taxable social security income above)
Standard deduction $7100 + additional deduction $3650
Taxable Income: $9750
Federal taxes: $1045
Effective federal tax rate: $1045 / $32000 ~ 3.3%

The (effective) tax rate is of course quite a bit larger than what FUEGO pays at over $100k income...

Question: what's their marginal rate? If you guessed 15%, you are actually wrong...

For every additional dollar of income, $0.50 more of social security is taxed, so real marginal rate is 22.5%

If retiree wanted to stay in 10%-bracket, i.e. to ensure that both bracket is smaller and none of Social Security benefits are taxed, they could withdraw maximum of $19,000 in above scenario, resulting in

AGI: 19000 (19000 + 0 taxable social security)
...
Federal taxes: $825
Effective federal tax rate of $825 / $31000 ~ 2.7%
Marginal federal tax rate: 10%

Effective tax rate is still quite a bit larger than OP...

What's a poor retiree to do?

With such a low AGI, most of your health care costs would be deductible. Once you add your medicare premiums, supplemental insurance premiums, medicare part D premiums, qualified long term care insurance premiums, medical co-pays, and medical mileage to your property taxes and a few charitable contributions, it's not hard to go well over the standard deduction.

 

[jimnjana]

With such a low AGI, most of your health care costs would be deductible. Once you add your medicare premiums, supplemental insurance premiums, medicare part D premiums, qualified long term care insurance premiums, medical co-pays, and medical mileage to your property taxes and a few charitable contributions, it's not hard to go well over the standard deduction.

Think you need to consider that medical expenses are not deductible until they exceed 7.5% of AGI, and that fact that someone with 20k of retirement income probably is not paying LTCI and is not contributing much to charities. The vast majority of tax returns that I prepare for seniors(VITA volunteer) in this situation take the standard deduction. The change during 2008 and 2009 tax years allowing people to add up to 1000 to standard deduction for married filing joint returns for property taxes (500 for singles) is a good thing for many people.

 

[FIREd]

Think you need to consider that medical expenses are not deductible until they exceed 7.5% of AGI, and that fact that someone with 20k of retirement income probably is not paying LTCI and is not contributing much to charities. The vast majority of tax returns that I prepare for seniors(VITA volunteer) in this situation take the standard deduction. The change during 2008 and 2009 tax years allowing people to add up to 1000 to standard deduction for married filing joint returns for property taxes (500 for singles) is a good thing for many people.

I am perfectly aware that medical expenses cannot be deducted until they reach 7.5% of AGI (which is not much when your AGI is $20K or less). I helped my MIL prepare her tax return last week. She made less than $23K in 2009 (I can't remember her AGI). Her medical expenses totaled more than $8K for that year (yes she still pays for LTCI). She also contributed almost $1K to charities and paid more than $1K in property taxes. Given that being on Medicare is hardly the bargain people make it out to be, medical costs can add up very quickly.

 

[kumquat]

Is that 43% top rate inclusive of local/state/provincial taxes or merely federal taxes?

Combined provincial/federal. Seems to have changed again this year.

It is so complicated to really figure it out and understand how everything works together that I am not sure how to determine the actual marginal rate.

I find mine here, yours (of course) aren't listed.

 

[militaryman]

Interesting thread ---

My comments are not really adressed at FUEGO but it's easy to use his example since it has gone back and forth so much

Incentives and Postponed taxes --

It seems to me the big reason that FUEGO has really low taxes right now is perfectly logical and to the benefit of the Federal Gov. and economy overall.

The Fed. wants folks to save for retirement ----The retirement contributions will be taxed in the future, he has only delayed it.... quite possibly if he dies before he withdrawls them an estate tax may take a huge percentage of them.

The Fed wants the house building market to surge and therefore offers mortgage interest deductions.... it creates jobs.

The Fed wants to incentivise people to become college educated. The college credits, child tax credits and dependent deductions all serve to provide incentive to people.

College educated Americans will compete for better paying jobs worldwide and bring greater wealth to the US to be taxed.

Child tax credits and higher dependent deductions provide incentive (make it less costly) for people to have children which the government sees as the future tax base.

As soon as FUEGO stops doing what the Fed. Gov. wants him to do (having kids and sending them to college and buying housing) then his tax bill will rise. He just happens to be at a time in his life when the stars are aligning tax wise (kids, a mortgage etc) This will peak and end soon enough unless he wants a perpetual mortgage payment, continues to be fruitful and multiply or he can find other ways to trade his tax burden for fulfilling the Gov's desire.

 

[FUEGO]

As soon as FUEGO stops doing what the Fed. Gov. wants him to do (having kids and sending them to college and buying housing) then his tax bill will rise. He just happens to be at a time in his life when the stars are aligning tax wise (kids, a mortgage etc) This will peak and end soon enough unless he wants a perpetual mortgage payment, continues to be fruitful and multiply or he can find other ways to trade his tax burden for fulfilling the Gov's desire.

In my case, unless they change the tax laws significantly, I doubt they will ever get very much more out of me. The kids will serve nicely to haul in the deductions and credits through age 17+, and then for a few more years with the college tax deductions and credits (plus tax free withdrawals from the 529 plans). So I have about 16-18 more years of significant tax savings before the kids finish college.

But I only have 7-10 more years of work until I'm completely financially independent and may stop working or cut back big time (if I don't do so sooner by semi-FIREing). In other words my income will drop big time before my child related tax deductions go away. My withdrawals and taxable income will be rather modest in ER, and a significant portion of income will be dividends, capital gains distributions and return of capital from sale of appreciated equities, tax free withdrawals from 529's, Roth IRA's, HSA's etc. Hence very little in the way of taxes in ER as well. Eventually, if I am lucky, I may pay big taxes on big RMD's from IRA's. But that is still 41 years away. I may dodge the tax man for the most part while still becoming modestly wealthy.

I also don't itemize my deductions, so the benefits of having a mortgage, paying a lot of state tax, making charitable contributions, etc does me no good to properly incentivize my activities. However I do still have a mortgage and own a house.

I agree that from a societal perspective a number of the incentivized activities are worthwhile (education and education savings, retirement savings, healthcare savings, wealth building). So the social engineering is working to encourage activities that are desired. But part of the reason these activities are desired is, from the State's perspective, self serving.

Having wealthy citizenry means the State doesn't have to support them with welfare and transfer payments, and they can tax the wealth (directly or through income and capital gains tax). Having citizenry with health care savings means less funds required to pay for the sick. Having education savings means college age children are ineligible for expensive State subsidized educational loans. Having retirement funds means more taxes can be assessed on future SS benefits, or if means testing is implemented, no SS funds will be due to the wealthy. It also means individuals are not eligible for medicaid until they have exhausted their assets, hence more savings accruing to the government.

It is interesting that for one who takes advantage of all these tax breaks, one can slowly grow wealthy by letting others less attentive of their tax situation, or others more successful financially, bear the burden of supporting the State and its spending and welfare programs. I guess the trick is acquiescing to being a grasshopper and being comfortable with your station in life, while watching the ants march on.