Reflections on Taxes

[ziggy29]

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%

Yeah, this taxation of SS really skewered my mom when my dad passed away. Not only did his death kick her from the 15% to the 25% tax bracket (on less income) because of single filing status, that change in status also caused 85% of her SS to be taxed instead of 50%.

The net effect of my dad's passing was that her federal income taxes roughly doubled despite lower income because of the loss of her (smaller) SS check.

 

[W2R]

Yeah, this taxation of SS really skewered my mom when my dad passed away. Not only did his death kick her from the 15% to the 25% tax bracket (on less income) because of single filing status, that change in status also caused 85% of her SS to be taxed instead of 50%.

The net effect of my dad's passing was that her federal income taxes roughly doubled despite lower income because of the loss of her (smaller) SS check.

One aspect of marriage in the U.S. is that it is a financial arrangement. Single people do have different tax rates as you pointed out, and can't claim a spouse on the tax return.

Also, the married person has a spouse as a "roommate", of sorts and a new widow or widower may find that it is hard to come up with the rent or mortgage without a roommate.

 

[ziggy29]

One aspect of marriage in the U.S. is that it is a financial arrangement. Single people do have different tax rates as you pointed out, and can't claim a spouse on the tax return.

True. And even so, apart from the tax fairness issue, it's something that people will need to consider in their retirement planning. IMO they should run the numbers and see if it still works if either of them is widowed, keeping in mind that it will likely result in lower income and higher taxes. If the numbers barely work while under MFJ tax status, they'll likely fail miserably in widowhood unless there's sone life insurance to offset it.

 

[W2R]

True. And even so, apart from the tax fairness issue, it's something that people will need to consider in their retirement planning. IMO they should run the numbers and see if it still works if either of them is widowed, keeping in mind that it will likely result in lower income and higher taxes. If the numbers barely work while under MFJ tax status, they'll likely fail miserably in widowhood unless there's sone life insurance to offset it.

That's for sure. Also a new widow or widower may have a hard time taking on all the budgeting and investing, especially if the other spouse was the one who did it. I think it is really important as one gets older to make sure both partners participate.

As a single person, this will not be an issue for me. But I have known married people for whom this was a huge problem.

 

[John Galt]

how did you guys learn all of this stuff? I understand most of the investing stuff on this website but all of this tax lingo is way over my head. specifically what do you recommend i do to learn?

 

[LOL!]

how did you guys learn all of this stuff? I understand most of the investing stuff on this website but all of this tax lingo is way over my head. specifically what do you recommend i do to learn?

Do not have anyone else fill out and file your tax return.

If you do your own taxes each and every year, then after 20 to 40 years of doing tax returns, you know something about taxes.

 

[John Galt]

there's got to be some good books out there. I'm in college so my tax returns are pretty simple

 

[RonBoyd]

there's got to be some good books out there. I'm in college so my tax returns are pretty simple

Yes. Now is the time to start. Just jump in. The mistakes you make at this stage of your life will not be very important... nor long lasting. This is truly a case of "When the student is ready, the Guru will appear."

(I was thinking Tax mistakes when I wrote that but it probably applies equally to other aspects of your life as well.)

 

[FUEGO]

John Galt, just read. Do your own taxes. If you have Volunteer Income Tax Assistance program in your area, volunteer. They will train you and you get hands on experience preparing others returns. I did that during law school and found it helpful to expose me to different tax situations from just my own personally. Also I took a number of tax law and business law type of courses during law school.

Read the 1040 instructions if you have a question. Work through the worksheets or an example to help explain how a concept works. Read the sections of Publication 17 that you are interested in given your situation.

My take is that earning a nice income is a good way to get wealthy. Understanding tax laws and how to structure your affairs to minimize taxes makes you wealthy quicker and keeps you wealthy longer.

 

[smjsl]

I find this list of deductions from FUEGO very interesting and revealing... (thanks again for posting FUEGO!)

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

I have a couple of questions about FSA and HSA plans. FSA implies to me that FUEGO spends at least $5000 / year on health expenses, since FSA expenses don't roll over, but then does it make sense to have HSA plan instead of a "normal" employer plan?

With 6k contribution to HSA, let's say you are saving $1.5k in taxes which you will never have to pay, or probably even less with all the other deductions and credits in FUEGOs case... so you are still spending at *least* 5k-1.5k=3.5k per year on medical expenses. Would not "standard" employer plan be better?

I don't visit doctors much, so I don't bother with FSA plans at work, but I am still having trouble imagining switching to a plan where a simple doctor visit would cost me $200 instead of $20. Then add any kind of labs / tests / etc, and even with limited use, I can easily see $1k / year spent on HDHP. For a single person like me this might get offset by at most $3k*50% (~1.5k) in HSA tax-saving benefits, but then you also have to think 3 times about going to doctors, which is not something I like to do. I guess if you or your spouse is a doctor, that might work but otherwise, why bother?

Also, what is "Medical, dental ins comes out pretax = $1000 deduction"? Is it because 5k in medical spending minus 7.5% of AGI is ~1k? But that would be under itemized deductions, not with FUEGOs standard deduction... so, where is this coming from?

Overall, even though FUEGOs taxes are low, it seems like a lot of it is because of high medical expenses, student loan expenses, capital losses (most likely due to TLH, i.e. shifting taxes to future by lowering basis). Most noticeably though, they are low simply because of being married and having kids.

For a healthy single person with a bit more income, only ~16k in 401k deductions would be possible + 6200 in std deduction (+real estate taxes) + 3650 (pers. exemption); i.e. $26k instead of $82k in deductions, let alone child credits.

 

[stephenandrew]

Originally Posted by FUEGO
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

How do you have both an FSA and HSA? Per the IRS:

My employer offers an FSA, can I have both an FSA and an HSA?
You can have both types of accounts, but only under certain circumstances. General Flexible Spending Arrangements (FSAs) will probably make you ineligible for an HSA. If your employer offers a “limited purpose” (limited to dental, vision or preventive care) or “post-deductible” (pay for medical expenses after the plan deductible is met) FSA, then you can still be eligible for an HSA.

I have an HSA and a limited purpose FSA, but only put about $1000 into the FSA as I will have no where near $5000 in vision, dental, or other preventive care services. What are you spending your FSA money on? Braces for the kids?

 

[FUEGO]

How do you have both an FSA and HSA? Per the IRS:

My employer offers an FSA, can I have both an FSA and an HSA?
You can have both types of accounts, but only under certain circumstances. General Flexible Spending Arrangements (FSAs) will probably make you ineligible for an HSA. If your employer offers a “limited purpose” (limited to dental, vision or preventive care) or “post-deductible” (pay for medical expenses after the plan deductible is met) FSA, then you can still be eligible for an HSA.

I have an HSA and a limited purpose FSA, but only put about $1000 into the FSA as I will have no where near $5000 in vision, dental, or other preventive care services. What are you spending your FSA money on? Braces for the kids?

FSA is for child and dependent care expenses. We pay our mother in law above the table $5000 a year. Up to $5000 a year can be contributed to child and dependent care FSA. HSA is a separate animal of course, with its own contribution cap.

 

[FUEGO]

I have a couple of questions about FSA and HSA plans. FSA implies to me that FUEGO spends at least $5000 / year on health expenses, since FSA expenses don't roll over, but then does it make sense to have HSA plan instead of a "normal" employer plan?

With 6k contribution to HSA, let's say you are saving $1.5k in taxes which you will never have to pay, or probably even less with all the other deductions and credits in FUEGOs case... so you are still spending at *least* 5k-1.5k=3.5k per year on medical expenses. Would not "standard" employer plan be better?

I don't visit doctors much, so I don't bother with FSA plans at work, but I am still having trouble imagining switching to a plan where a simple doctor visit would cost me $200 instead of $20. Then add any kind of labs / tests / etc, and even with limited use, I can easily see $1k / year spent on HDHP. For a single person like me this might get offset by at most $3k*50% (~1.5k) in HSA tax-saving benefits, but then you also have to think 3 times about going to doctors, which is not something I like to do. I guess if you or your spouse is a doctor, that might work but otherwise, why bother?

Also, what is "Medical, dental ins comes out pretax = $1000 deduction"? Is it because 5k in medical spending minus 7.5% of AGI is ~1k? But that would be under itemized deductions, not with FUEGOs standard deduction... so, where is this coming from?

Overall, even though FUEGOs taxes are low, it seems like a lot of it is because of high medical expenses, student loan expenses, capital losses (most likely due to TLH, i.e. shifting taxes to future by lowering basis). Most noticeably though, they are low simply because of being married and having kids.

For a healthy single person with a bit more income, only ~16k in 401k deductions would be possible + 6200 in std deduction (+real estate taxes) + 3650 (pers. exemption); i.e. $26k instead of $82k in deductions, let alone child credits.

See my post immediately above about FSA vs HSA. The FSA expenses are solely childcare for our kids. HSA is for healthcare.

We do pretty well with DW's family High Deductible plan. Roughly $415 a year and the "high" deductible is only $3000 for family coverage, 80% paid after that. We could pay a few thousand bucks a year more for health insurance with no deductible, just copays. But there are very few scenarios where that would work out to our advantage, given the tax savings with the HSA+HDHP. The extra premiums for the no deductible plan would basically pay for our $3000 deductible every year. In years where we have low medical expenses we save money with the HDHP. In years where we have high medical expenses, the HDHP and no deductible plans would roughly be on par in terms of total cost.

Our total medical+dental+over the counter medical expenses have been running between $800-900 a year for the last three years (amazingly constant expenses!). Only a part of that is medical. As you can see for our family of 4, we don't spend a lot on doc's visits. Physicals and baby/child wellness visits are free (including labwork and immunizations), flu shots are free. When we pay out of pocket, the prices typically run $50 for a simple office visit without labwork, to $180 for a specialist visit with lots of labwork or x-rays. Remember we don't pay sticker, we pay the insurance company's negotiated price. Our copays would be $25 for a doc visit or $50 for a specialist with the no deductible plan, so we really aren't out of pocket that much more with the HDHP for a normal doc's visit. And I guess we are lucky that we are healthy and not big risk takers, hence don't require a lot of medical services.

"Medical, dental ins comes out pretax = $1000 deduction" - our med and dental insurance premiums are paid pre tax out of DW's paycheck. Hence, that income (roughly $1000 a year) is not taxed. Basically the same as a deduction from income, but not reported on the 1040 tax form (since the income is never counted as income on a w-2).

Agreed as to your conclusion - our taxes are particularly low because we are married and have kids. At least this will remain true for 2010. 2011 will come with a big punch in the face (tax-wise) to couples married with kids. Bush tax cuts expire, marriage penalty kicks back in, and child tax credits are slashed in half. This will cost me roughly $3000 in fed taxes. It will be interesting to see if any big deal is made in the media about the tax increases "married with kids" folks are facing in a little over 8 months (or more likely a big fat check they will be writing sometime before April 2012!).

 

[smjsl]

See my post immediately above about FSA vs HSA. The FSA expenses are solely childcare for our kids. HSA is for healthcare.

Oh, so FSA can be used for baby-sitting? Nothing medical related? Did not know that...

Thanks for explaining HDHP+HSA a bit more. I guess in my case, I pay ~$1300/year for the employer plan + ~$240 for dental and vision. Wonder if I am allowed to drop employer insurance at Megacorp and go with HDHP+HSA... I would need to find out if my doc's negotiated rate would also be $50 for such a plan... I assumed it would be a sticker price.

2011 will come with a big punch in the face (tax-wise) to couples married with kids. Bush tax cuts expire, marriage penalty kicks back in...

What's this marriage penalty? Right now I feel like I am paying a huge "unmarried" penalty... If I went and married someone off the streets, seems like there would be a LOT of taxes coming my way... hmmm.. sounds like a business plan

 

[Alan]

What's this marriage penalty? Right now I feel like I am paying a huge "unmarried" penalty... If I went and married someone off the streets, seems like there would be a LOT of taxes coming my way... hmmm.. sounds like a business plan

Be careful - it's easy to lose a whole load of money while trying to minimize taxes

 

[ziggy29]

What's this marriage penalty? Right now I feel like I am paying a huge "unmarried" penalty... If I went and married someone off the streets, seems like there would be a LOT of taxes coming my way... hmmm.. sounds like a business plan

The "marriage penalty" was a situation which often hit two-income couples before the tax cuts, especially when both earned comparable income.

Basically, if a husband and wife each earned $40K, the total tax they combine to pay filing even a joint return on $80,000 is higher -- perhaps significantly -- than it would be if each earned $40K and "shacked up" filing single.

The tax cuts eliminated the "marriage penalty" and set the exemptions, standard deductions and tax brackets as exactly twice the single rate in most cases. This is set to expire in 2011, I believe. And even with the "marriage penalty," if one spouse earns a lot more than the other (or you're a one-income household), you would be better off MFJ. It's when both spouses earn roughly the same income when the marriage penalty really bit couples in the butt.

In other words, if you "married someone off the street" who earned the same income as you, if the marriage penalty was restored you would be paying more per person in tax than you would today filing single.

 

[FUEGO]

Oh, so FSA can be used for baby-sitting? Nothing medical related? Did not know that...

Thanks for explaining HDHP+HSA a bit more. I guess in my case, I pay ~$1300/year for the employer plan + ~$240 for dental and vision. Wonder if I am allowed to drop employer insurance at Megacorp and go with HDHP+HSA... I would need to find out if my doc's negotiated rate would also be $50 for such a plan... I assumed it would be a sticker price.

We benefit a lot from having DW's employer provide the HDHP and HSA as a pretax benefit. We don't pay the 7.65% SS/Medicare tax on the HDHP premiums or HSA contributions, nor do we pay state or fed income tax on those premiums or contributions. If you paid HDHP insurance premiums out of pocket, you would likely not get to deduct those from state/fed income.

All of our doc visits are billed to the insurance first, then we later are billed by the doctor at the negotiated rate set by the insurance company. So our bill from the doc is something like:

Office Consultation Lvl III - $140; insurance write off $68, patient responsibility $72
Labwork - $71; insurance write off $59; patient responsibility $12.
Total Due: $84
And that is roughly the scale of the write offs we see. Usually about 1/2 or less of the "rack rate" is what we end up paying.

What's this marriage penalty? Right now I feel like I am paying a huge "unmarried" penalty... If I went and married someone off the streets, seems like there would be a LOT of taxes coming my way... hmmm.. sounds like a business plan

Right now, the tax brackets, standard deductions, and a number of other values for a married couple are basically 2x the size of those for a single person. In other words, when DW and I earn the same salary, we are each paying the same amount of tax as each one of us would pay separately were we not married. Next year that ends, and our tax brackets, standard deduction, income based phase outs, etc all shrink to less than 2x those of a single person.

You are right - there is a marriage bonus in effect now. You could marry a homeless bum off the street and instantly double your tax bracket size, standard deductions, etc (through the end of the year). In 2011, DW and I could do a paper divorce and similarly gain thousands of dollars per year by lowering our taxes. She wasn't interested in the idea for some reason... that's a good sign right?