Reflections on Taxes

[FUEGO]

I finished up the taxes this past weekend. Thanks to a salary reduction for me and the ample capital loss carryovers from 2008, we paid even less tax for 2009 versus 2008.

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.

This is on cash compensation that is just a little bit into six digits, with total compensation significantly more.

I guess I'm surprised at how little federal tax someone like our family pays. I guess it is indicative of us taking advantage of tax savings where we can. Any others still in the accumulation phase with six figure household incomes seeing similarly small tax bills?

Of course one of my long term wealth building goals is to minimize my tax burden, so we have been very successful at accomplishing this goal.

 

[FinanceDude]

Somtimes its easier to accomplish that BEFORE retirement than after..............

 

[LOL!]

We are not in the sub-1% range, but we also pay little taxes. The reasons are low wage income (under $200K), max out pre-tax retirement plan contributions, flexible spending account (no tax, no FICA either!), charitable contributions, child tax credits, foreign tax credits, Making Work Pay tax credits. Next year, we will get $2500 for the American Opportunity credit.

Folks with middle class incomes and kids probably don't pay any taxes at all. It seems like only folks with more than $200K in wages really pay any income taxes along with folks who spend all their money instead of putting it into retirement plans. And of course all those folks who aren't married or who do not have kids.

 

[FUEGO]

We are not in the sub-1% range, but we also pay little taxes. The reasons are low wage income (under $200K), max out pre-tax retirement plan contributions, flexible spending account (no tax, no FICA either!), charitable contributions, child tax credits, foreign tax credits, Making Work Pay tax credits. Next year, we will get $2500 for the American Opportunity credit.

Folks with middle class incomes and kids probably don't pay any taxes at all. It seems like only folks with more than $200K in wages really pay any income taxes along with folks who spend all their money instead of putting it into retirement plans. And of course all those folks who aren't married or who do not have kids.

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.

We missed the retirement contribution credit by $4000 too much income (which means on that $4000 we paid an extra $400 in tax on top of our combined 22% bracket, or a 39.65% effective marginal rate). And all of that $4000 of income was dividends and interest income from... wait for it... retirement savings. So because we have been successful at saving for retirement, we are no longer eligible to receive Retirement Contribution Tax Credits.

"Folks with middle class incomes and kids probably don't pay any taxes at all."

Definitely agree with that statement at least in regards to federal income taxes. Seems like most families earning $100k or less with a couple of kids shouldn't be paying hardly any federal income taxes assuming they take advantage of the multitude of options available to save on taxes. I guess this explains the stat that "half of all families pay no federal income tax" or whatever the number is. And if either DW or I was not working, we could potentially get all kinds of refundable credits like child tax credit and earned income credit.

What a strangely inequitable tax code we have when very comfortable middle class families pay virtually no federal income tax.

 

[FIREd]

Let's see: total gross compensation was north of $310K last year, the vast majority W-2 income.

We paid over $62K in Federal income tax and about $10K in state income tax.

That's despite having a tax efficient portfolio (very little taxable income except a few dividends taxed at 15%), and that's after maxing out retirement accounts (really only DW's 401K since I can't make deductible IRA contributions anymore and don't have access to a 401K), making a fairly large charitable contribution and using some of my capital loss carryover from 2008. Except for a small mortgage, no other deductions. No kids either.

So, no I am nowhere near the sub 1% level (nor should I be).

 

[ziggy29]

Folks with middle class incomes and kids probably don't pay any taxes at all. It seems like only folks with more than $200K in wages really pay any income taxes along with folks who spend all their money instead of putting it into retirement plans. And of course all those folks who aren't married or who do not have kids.

Guilty. No kids here, no mortgage interest, no itemizing. All we could do is max the 401K and HSA, and get $550 in tax credits from the new roof we put up last year. Still wound up paying about 11% of gross pay in federal income tax -- and with a total gross income that is well under the $200K you mentioned.

This thread reminds me of why an AMT was created. If people are making six figures and paying almost no tax, IMO there's a problem. I don't blame anyone for taking maximum advantage of legal tax reduction strategies, but still...

 

[FUEGO]

Somtimes its easier to accomplish that BEFORE retirement than after..............

True, but our social security/medicare taxes would go to zero.

I think we'll do ok, since our withdrawals will come from a mix of roth and trad IRA on a SEPP/72t, taxable sales that are return of capital and tax favored cap gains, hopefully tax favored dividends, etc. Maybe a little earned income tossed in if there are tax benefits to working.

 

[FUEGO]

This thread reminds me of why an AMT was created. If people are making six figures and paying almost no tax, IMO there's a problem. I don't blame anyone for taking maximum advantage of legal tax reduction strategies, but still...

I don't mind paying a more equitable share of income taxes, but I'd hate to have to deal with AMT as just another regular Joe trying to make a living. Why not get rid of all these credits, deductions, set asides, etc and actually simplify the tax structure. Reduce the marginal tax rates for each bracket in a revenue neutral manner using the increase in revenue after you get rid of all these special credits, deductions, set asides.

 

[ziggy29]

Agreed. I'm not advocating for the AMT, but it is a reminder of why it was put into place. Like you, I'd prefer a simpler and flatter structure with very few (if any) deductions.

I suspect a lot of economically suboptimal decisions are made because of the tax code, and I suspect scrapping it and taking out the complexity and uncertainty of ever changing nuances of a complex tax code would unlock some positive economic benefits.

 

[Alan]

Married, no kids at home, standard deductions, 2009 income mostly from W-2's north of $200K, federal effective tax rate 19.5%. Maxed out 401(k)'s, not eligible for HSA but did contribute as much as I dared to an FSA. Medical insurance through company is also deductible ($960/year).

AMT would have me paying ~$2K more, but I'd be happy to have AMT, or some simpler scheme, with a lot fewer deductions and credits, apply to everyone.

 

[FUEGO]

This thread was mostly prompted by me playing Monopoly while taking a break from doing my taxes. I landed on the "income tax" square, where you pay $200 or 10% of your assets. I remarked at the time how nice it would be if the method of calculating real life taxes were that simple - ie if it only took 1 minute to calculate on the back of an envelope.

Not advocating for a flat tax, or a 10% tax on wealth or anything, just my general thoughts/comments after completing this annual ritual. Also interesting when I look back at a set of 1040 tax instructions and forms from 1950-something that I found in my grandparents' basement a while back. I think the whole booklet had 16 pages including the forms. Ahhh, simpler times.

 

[LOL!]

And how could I forget the $-3000 in capital losses to reduce AGI? We had less than $10 in interest income since we keep our emergency fund in an IRA. We do not load up on tax-exempt stuff either, so no tax-exempt interest income lurking about either.

 

[FUEGO]

And how could I forget the $-3000 in capital losses to reduce AGI?

Since I'm in the 15% federal bracket, I wish I could have had the massive capital losses in 2011 instead of 2008. Then I could use up the 0% CG bracket that resides within the 15% ordinary income bracket.

In the meantime, my capital loss carryovers are beating slowly eaten by CG gains.

 

[smjsl]

FUEGO, are you paying 0.4% of your total gross income for federal income taxes, including federal deductions from paychecks! Does this mean that if you make $100k, your total is $400 tax, so for example your paystub deduction is less than $20 for federal income tax assuming 24 paychecks? That's amazing...

(Also, is this ~$100k for 2 people? You mentioned you can contribute to 2 full traditional IRAs...)

I have not started my taxes yet (K1 schedules will not arrive for another month or so), but last year I was paying ~26% average/effective rate (single, no kids, no major deductions except for itemizing state/local/property taxes, maxing out 401k, ineligible for TIRA). I expect the same or worse this year.

P.S. And yes, there are countries out there that have a flat N% rate on their income. Wish, it was the same in the US!

P.P.S. Did you know that when paying AMT, your marginal tax rate is actually higher than 35%? US does not have a progressive tax system - if I recall correctly, once you make enough money to get you over AMT "hump", your marginal rate drops to 35%.

 

[haha]

I finished up the taxes this past weekend. Thanks to a salary reduction for me and the ample capital loss carryovers from 2008, we paid even less tax for 2009 versus 2008.

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.

This is on cash compensation that is just a little bit into six digits, with total compensation significantly more.

I guess I'm surprised at how little federal tax someone like our family pays. I guess it is indicative of us taking advantage of tax savings where we can. Any others still in the accumulation phase with six figure household incomes seeing similarly small tax bills?

Of course one of my long term wealth building goals is to minimize my tax burden, so we have been very successful at accomplishing this goal.

If your tax rate is this low, might it be beneficial to realize some of that income now, instead of later whenit comes out of the tax deferred accounts?

Ha

 

[FUEGO]

If your tax rate is this low, might it be beneficial to realize some of that income now, instead of later whenit comes out of the tax deferred accounts?

Ha

My marginal rate is still 22% state and federal. And I plan to realize lower income during ER, hence putting me in the same tax bracket most likely.

However I am going to roth IRA contributions for 2010 instead of traditional IRA partly to "tax diversify" the portfolio. That will cost me $2200 in additional tax liability, assuming my AGI doesn't increase to the point of phasing out some other deduction or credit. Or my income shoots up due to a change in the job situation.

The consensus here seems to be that higher tax rates are coming in the future. But being a contrarian, I could also see similar or lower tax rates for those who have below median incomes. Or enough credits, deductions, subsidies, benefits, etc to offset any tax liability I would otherwise have.

When you are a politician* trying to buy votes, it is cheaper to get the lower income votes, since tax subsidies and handouts are cheap at the low income level.

* Mods: not trying to discuss politics here, just explaining my rationale for my outlook on future tax rates and the underlying political considerations that form the basis of my opinion and rationale.

 

[FUEGO]

FUEGO, are you paying 0.4% of your total gross income for federal income taxes, including federal deductions from paychecks! Does this mean that if you make $100k, your total is $400 tax, so for example your paystub deduction is less than $20 for federal income tax assuming 24 paychecks? That's amazing...

(Also, is this ~$100k for 2 people? You mentioned you can contribute to 2 full traditional IRAs...)

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). The actual numbers are proportional but a bit higher than that. That is for DW and I. Pretty amazing I think too.

The withholding was higher than $20/paycheck because we received a significant refund over $3000. Most of the time the refund is much smaller, but we did "well" this year by having a lower earned income and capital losses, among other things. Changing to contributing to Roth instead of Traditional will make our refund much closer to zero this year.

Just checked DW's paycheck. $16 withheld for federal tax each check, 24 checks a year. Mine is over $100 a check.

 

[Shawn]

Any others still in the accumulation phase with six figure household incomes seeing similarly small tax bills?

Not even close.

Relative to my AGI (~$180K), which isn't too far under my "gross compensation," my total effective tax rate for 2009 was 34.6% and my marginal tax rate was 43.5%. That includes all taxes that I openly see (including property and sales tax). My effective federal income tax rate was over 19%.

And I believe I'm a relatively tax conscious person, although I did make the mistake of partially contributing to a Roth 401k instead of a regular 401k (a mistake because I'm subject to the AMT). Sure, I could do certain things to make my taxes smaller, but those things would have an impact greater than the tax bite.

 

[calmloki]

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.

 

[FUEGO]

You are welcome.

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.

Yes, thank you to all of you patriotic taxpayers out there! Our family has it hard, at roughly 5-6 times the poverty level it can be really difficult to max out the 401k's, IRA's, 529, HSA, FSA, etc and keep nice vacations coming, and put food on the table.

Tax strategy does inform my investing decisions to a certain extent. Dividend income is favored vs interest income, so a 4% dividend yield is much prettier to me than a 4% payment from a CD. And the underlying principal appreciation of stocks is not realized until the time of sale.

 

[Nords]

What a strangely inequitable tax code we have when very comfortable middle class families pay virtually no federal income tax.

Oh, I think we're all adequately taxed at the state, local, and consumption levels. I don't see an upside to sending more to the feds.

I'm in the "soak the rich" camp, and even Forbes admits that today's marginal tax brackets are far better than the 91% rate of the Eisenhower era.

As for the tax code, the realistic fix (whatever it is) would be to implement it only for those under the age of 21 with the rest of the American population voluntarily or mandatorily phasing in over 10-25 years. Do it in a manner that would make most of us look forward to dying first.

 

[stephenandrew]

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.

 

[walkinwood]

This is a very revealing thread. With two incomes & no kids, we were paying about 20% of our income to Federal taxes before we semi-ER'd.

 

[LOL!]

I think I posted this link previously, but without explanation: A Line-by-Line Walk Through the 1040 - Interactive Feature - NYTimes.com. With an AGI of about $120K, the NY couple had an income tax of $12,906 but got to subtract tax credits of $3450 + $1800, so their income tax was $7656.

Suppose they put $22K each into their 401(k)s (they did not) and had an FSA of $2K (not sure about that) and paid health insurance premiums out of W2 pre-tax (say $5K), then they could've had about $170K gross income and paid about 4.5% of their gross income in Federal income taxes.

 

[ziggy29]

I'm in the "soak the rich" camp, and even Forbes admits that today's marginal tax brackets are far better than the 91% rate of the Eisenhower era.

How many of "the rich" actually paid that 91% marginal rate? Or even the top 70% rate after the JFK tax cut? There were so many deductions, shelters and loopholes that anyone with a decent CPA could shield the vast majority of income from taxation then.