Perspective on Income Taxes

[pb4uski]

While from a public policy perspective it's tempting that everyone that has income pays income tax, even if it is just a little, the practical reality is that it would be an administrative nightmare, adding tens of millions of tax returns to collect $100-$1,000 per taxpayer or household. And the IRS is stretched so thin they can't go after the bigger fish. Besides, if you have millions of low income people filing tax returns how many errors are likely? It's the stuff of nightmares.

 

[CardsFan]

I'll try to get back on topic.

My data does not go as far back as Midpack's, but from what I can pull together, in the 2000's while working our Fed effective tax rate ranged from 15% to 20%. I am sure it was higher in the 80's and 90's.

Since retiring, our effective Fed rate has been as low as 5-6% (Roth conversions only in the 12% bracket, no SS), to a high of 12% (Roth conversions almost to the top of the 22% bracket and started SS).

Since current conversions are about what our RMD's would be if we started today, around 12% is where I expect us to be for at least the next 10 years (of course if the current brackets sunset, then a few points higher).

So, I can b*tch and moan and complain about taxes, or I can look at this and say "In the grand scheme of things, our taxes are pretty reasonable"

 

[braumeister]

if you have millions of low income people filing tax returns how many errors are likely? It's the stuff of nightmares.

When this income tax began, over a century ago, the first 1040 form was four pages long with one page of instructions. Even worse, there were no tables with precalculated amounts; the taxpayer had to actually do the math. I shudder to think what that would be like for most people today. Truly a nightmare.

 

[aaronc879]

The proposal actually eliminates income tax, estate tax and corporate income tax.

What about State sales tax. Is this in addition to the State tax?

 

[MichaelB]

While from a public policy perspective it's tempting that everyone that has income pays income tax, even if it is just a little, the practical reality is that it would be an administrative nightmare, adding tens of millions of tax returns to collect $100-$1,000 per taxpayer or household. And the IRS is stretched so thin they can't go after the bigger fish. Besides, if you have millions of low income people filing tax returns how many errors are likely? It's the stuff of nightmares.

We do have more than 100 million people paying taxes on their incomes automatically with little effort or complications. They are payroll taxes, which are taxes on wages with another name.

 

[Cobra9777]

I guess all the mods have been napping today. This thread should have been shut down before post #10.

PLEASE don’t turn this thread into political commentary on income taxes, that was not the intent.

Well, when you use words like "confiscatory" in the OP, it's like poking a sleeping bear with a stick.

 

[fishfactory]

Midpack, I am also converting big time right now believing that they will raise rates drastically over time despite the fact that the total dollar amount actually collected varies little over the wide range of tax rates.

 

[Sunset]

We have laws on the books now in every state that has a sales tax which include a parallel tax on the "use" of goods otherwise subject to sales tax. It is called the "use tax" as in sales and use taxes.

So this issue is relatively easy to address.

For the average Joe they will pay on their car, and fishing boat, but if I buy a $40M yacht in Greece and register it in Antigua, my State won't even know about it, and I wouldn't feel any need to report it since the money was not spent in the USA.

Maybe it's one reason Cruise ships are registered in the Bahamas and not Florida.

 

[athena53]

For the average Joe they will pay on their car, and fishing boat, but if I buy a $40M yacht in Greece and register it in Antigua, my State won't even know about it, and I wouldn't feel any need to report it since the money was not spent in the USA.

Maybe it's one reason Cruise ships are registered in the Bahamas and not Florida.

On your last sentence- no, it's FAR more complicated than that. US-flagged vessels are subject to US maritime law, which means they can't get away with hiring nationals from developing countries and paying them crap wages, among other things.

On Use taxes: yeah, I was the average Jane- bought a car in IA because that's where my old one broke down, didn't have to pay IA taxes but got nailed with MO taxes when I registered it in MO.

But, to your point, the "rich" (however you want to define them) have alternatives ordinary mortals don't, some of them perfectly legal, such as re-domiciling to FL to avoid personal income taxes. Tax them beyond a certain level and they won't just sit there and pay them. They'll hire a good accountant and find a way out of them.

 

[sroby2020]

Federal taxes were WAY more confiscatory then! Looks outrageous to me today.

The current tax rates are abnormally low. I suspect that when they expire in 2025, the party that controls Congress/Senate will either jack them way up, or keep them low for a few more years. I would love it if they would stay low for the next 30 years... I guess if they go way up after 2025, then my conversions may stop.
I too, am doing my Roth conversions for about 7 more years, maxing out the conversions to the high end of the 24% bracket (MFJ). The main reason is that, as some have mentioned, with pensions, Social Security and then RMD's it would give me way more taxable income than I need or desire.

 

[Badger]

From 1973 to date I have been in the 24 to 28% tax rate. My income and later when remarried in 1987 the income increased along with the inflation rate. I started with a $7.2k annual income (in 1973 my first wife and I were in the >12k bracket with a 25% rate) and later when re-married my wife's income was about 60% of mine. Once we paid off our house and then began to increase our 403b to the maximum allowable amount to try and reduce income tax the rates really didn't change for our adjusted income. Now that we are retired and taking RMD the rate is 22% and closing in on 24%.
I guess I am better off than I thought.

Cheers!
Through that time there were a few ups and downs in gross income but it was also accompanied by ups and downs in tax brackets and rates only changed a few percentage points.

 

[DawgMan]

I know this has been discussed elsewhere, but I cannot put my fingers on it. Having just completed year 1 of retirement and done my first Roth conversion, I still bang around the pros/cons of Roth conversions vs IRA distributions. I am fortunate to have choices as to where I pull my withdrawals. At 58, DW and I can live on after tax accounts until 75 and do Roth conversions or save those $$ and live off tax deferred accounts. Here is what I am still trying to sort out...

Live off after tax/Roth conversions: This would lower/control taxes to some degree and would allow more Roth conversions (fill up 24% bracket). It would also in theory reduce the naturally occurring interest/dividends/capital gains since I am spending from my after tax accounts. More in Roth means better scenario for heirs and single spouse. Also, if you think taxes will higher in future (I do) more in Roth makes sense?

Live off tax deferred: This would be a combination of planned spend + smaller Roth conversion staying in 24% bracket. This would help deplete my tax differed accounts quicker lowering my RMD, however, my naturally occurring interest/dividends/capital gains would probably creep up since the after tax account would be left to grow. At the same time, my heirs would get a stepped up basis on this account.

I suppose I am just scratching my head wondering how anal I should get on one strategy vs the other? It seems if nothing else, I should do Roth conversions filling up the 24% bracket until 2025 then reevaluate but not sure how much of a dent that will make. . Frankly, I'm exposed to higher taxes by RMDs in either case. First world problem, not complaining, just trying to be prudent.

 

[Montecfo]

For the average Joe they will pay on their car, and fishing boat, but if I buy a $40M yacht in Greece and register it in Antigua, my State won't even know about it, and I wouldn't feel any need to report it since the money was not spent in the USA.

Maybe it's one reason Cruise ships are registered in the Bahamas and not Florida.

Well if not used in the US, it would be outside of the tax. The US does not tax your 3rd home in the Greek Isles either.



Cruise ships are registered outside the US for legal and liability reasons, but not wanting to be tied to to taxation on worldwide income does play a role.

 

[intent]

Back to the OP, I've found it a bit difficult to justify to DW exactly why doing Roth conversions and paying more in taxes than absolutely necessary now is a good idea. Ultimately, once I eventually stumbled upon the "tax smoothing" framing/word choice, it clicked with her.

For us, being without children and so not needing to concern ourselves with heirs, it also seems to make sense to shift as much $$ as reasonably possible to Roth to prevent one of us from being burdened with an inordinately high single tax rate due to high RMDs should the other pass prematurely.

 

[Midpack]

Back to the OP, I've found it a bit difficult to justify to DW exactly why doing Roth conversions and paying more in taxes than absolutely necessary now is a good idea. Ultimately, once I eventually stumbled upon the "tax smoothing" framing/word choice, it clicked with her.

For us, being without children and so not needing to concern ourselves with heirs, it also seems to make sense to shift as much $$ as reasonably possible to Roth to prevent one of us from being burdened with an inordinately high single tax rate due to high RMDs should the other pass prematurely.

Me too. The free online Roth IRA calculators told me our case was a wash more often than not. It was only when I actually projected the future of our portfolio accounts and the associated taxes that it was beyond obvious we should do conversions. We've been doing huge conversions since 2019, and it will definitely pay off IMO.

 

[Out-to-Lunch]

I know this has been discussed elsewhere, but I cannot put my fingers on it. Having just completed year 1 of retirement and done my first Roth conversion, I still bang around the pros/cons of Roth conversions vs IRA distributions. I am fortunate to have choices as to where I pull my withdrawals. At 58, DW and I can live on after tax accounts until 75 and do Roth conversions or save those $$ and live off tax deferred accounts. Here is what I am still trying to sort out...

Live off after tax/Roth conversions: This would lower/control taxes to some degree and would allow more Roth conversions (fill up 24% bracket). It would also in theory reduce the naturally occurring interest/dividends/capital gains since I am spending from my after tax accounts. More in Roth means better scenario for heirs and single spouse. Also, if you think taxes will higher in future (I do) more in Roth makes sense?

Live off tax deferred: This would be a combination of planned spend + smaller Roth conversion staying in 24% bracket. This would help deplete my tax differed accounts quicker lowering my RMD, however, my naturally occurring interest/dividends/capital gains would probably creep up since the after tax account would be left to grow. At the same time, my heirs would get a stepped up basis on this account.

I suppose I am just scratching my head wondering how anal I should get on one strategy vs the other? It seems if nothing else, I should do Roth conversions filling up the 24% bracket until 2025 then reevaluate but not sure how much of a dent that will make. . Frankly, I'm exposed to higher taxes by RMDs in either case. First world problem, not complaining, just trying to be prudent.

For me, Kitces has done the "classic" discussion of this topic: https://www.kitces.com/blog/tax-efficient-retirement-withdrawal-strategies-to-fund-retirement-spending-needs/

Of course, you will need a few items from your crystal ball to do this optimally!

 

[gayl]

... remember doing my first tax return as a retiree in 2012 and thinking - this can't be right! But it was right...

I can remember doing my 1st income tax return after retiring and not trading as much & had the same reaction. Actually sat on that return for a week as I thought it was too simple to be right. It was right

I don't even do estimates anymore. Just figure out what I might owe, take 1 IRA withdrawal in December (90% IRS, 9% state, 1% me) and both IRS & State regard it as being made throughout yr!!

 

[audreyh1]

I also distinctly remember doing my first tax return as a retiree in 2012 and thinking - this can't be right! But it was right.

I recall you being gobsmacked by the 0% capital gains tax rate up to a fairly high threshold before 15% rate applied which significantly lowered overall taxes for many of us retirees.

I got surprised by it too the first year it was in effect because I had way overpaid my estimated taxes not taking that change into account.

 

[audreyh1]

For us, being without children and so not needing to concern ourselves with heirs, it also seems to make sense to shift as much $$ as reasonably possible to Roth to prevent one of us from being burdened with an inordinately high single tax rate due to high RMDs should the other pass prematurely.

A strategy we intend to use is adding non-spousal beneficiaries to the IRAs. The IRAs are only about 20% of our investable assets so losing up to half of that would not be a burden on the surviving spouse. It’s also an easy way to pass funds along without waiting for both spouses to die.

In our case it would not place undue hardship on our heirs, but honestly I wouldn’t pay taxes ahead to spare our heirs anyway. And most of our assets are in taxable.

Surviving spouse would get stepped up basis in taxable accounts and thus an opportunity to realign assets to be more tax efficient if required. Then have only their own IRA or a smaller portion of their spouses in addition.

FWIW we also regularly gift to heirs and plan on continuously ramping that up as we age.

 

[Echard]

I know this has been discussed elsewhere, but I cannot put my fingers on it. Having just completed year 1 of retirement and done my first Roth conversion, I still bang around the pros/cons of Roth conversions vs IRA distributions. I am fortunate to have choices as to where I pull my withdrawals. At 58, DW and I can live on after tax accounts until 75 and do Roth conversions or save those $$ and live off tax deferred accounts. Here is what I am still trying to sort out...

Live off after tax/Roth conversions: This would lower/control taxes to some degree and would allow more Roth conversions (fill up 24% bracket). It would also in theory reduce the naturally occurring interest/dividends/capital gains since I am spending from my after tax accounts. More in Roth means better scenario for heirs and single spouse. Also, if you think taxes will higher in future (I do) more in Roth makes sense?

Live off tax deferred: This would be a combination of planned spend + smaller Roth conversion staying in 24% bracket. This would help deplete my tax differed accounts quicker lowering my RMD, however, my naturally occurring interest/dividends/capital gains would probably creep up since the after tax account would be left to grow. At the same time, my heirs would get a stepped up basis on this account.

I suppose I am just scratching my head wondering how anal I should get on one strategy vs the other? It seems if nothing else, I should do Roth conversions filling up the 24% bracket until 2025 then reevaluate but not sure how much of a dent that will make. . Frankly, I'm exposed to higher taxes by RMDs in either case. First world problem, not complaining, just trying to be prudent.

I am struggling with this too. I am one year removed from retirement and finally have lower self employment and wage income. However, 75% of funds are in after tax accounts and dividends and interest pushes us into higher tax brackets. I’m trying to figure out how to deal with this.

 

[EastWest Gal]

We made less than $40K in 1982, Federal taxes were WAY more confiscatory then! Looks outrageous to me today.

Thought others might have similar records or recollections - I'd forgotten.

$40,000 in 1982 dollars equals $118,424 in 2022 dollars.

The marginal tax rate after standard deduction and 2 personal exemptions ($40,000-$3400-$2000) would put one at 35% for a net income of $34,600. This does not take in account dependents and possibly a 401K (they just started in 1979) or an IRA contribution ($2000 in 1982). But the actual income tax paid would be 15.6%, or $6218.

In 2022, your tax on that $118,424 would be 9.8% filing jointly after the standard deduction. It puts those marginal tax rates in perspective, doesn't it?

 

[DawgMan]

For me, Kitces has done the "classic" discussion of this topic: https://www.kitces.com/blog/tax-efficient-retirement-withdrawal-strategies-to-fund-retirement-spending-needs/

Of course, you will need a few items from your crystal ball to do this optimally!

Thanks. Not sure I am that much clearer relative to my plan. What appears to be true is all things being equal, there are some additional benefits to doing Roth conversions to a specific tax bracket over just taking 100% from an IRA. For my first year (2022), I converted up to the NIIT threshold. In hindsight, I should have filled up the entire 24% bracket. Live and learn, my plan for this year.

 

[Koolau]

Thanks. Not sure I am that much clearer relative to my plan. What appears to be true is all things being equal, there are some additional benefits to doing Roth conversions to a specific tax bracket over just taking 100% from an IRA. For my first year (2022), I converted up to the NIIT threshold. In hindsight, I should have filled up the entire 24% bracket. Live and learn, my plan for this year.

Starting to think in terms of remaining spouse issues upon death of other spouse. Thinking mostly income taxes now. Probably needs its own thread, but...

If DW inherits my Roths, they don't add to her taxable income (at her single tax payer rate) upon liquidation as would happen when she inherits (and liquidates) my 401(k) or tIRAs, right? SO, Roths would have another advantage over any other form of wealth transfer among spouses. Right? Or am I thinking incorrectly?

 

[carty1]

Roth Conversions meh

voluntarily paying lots of extra taxes for Roth conversions since 2019 has been hard to stomach. But I know it's the right thing to do....

It depends if its "the right thing to do". Good for some, bad for others.
Who says taxes will be more expensive? Actually they would have to be ALOT
more before I would do a Roth conversion.
Probably a whole new discussion on this somewhere.

 

[DawgMan]

Starting to think in terms of remaining spouse issues upon death of other spouse. Thinking mostly income taxes now. Probably needs its own thread, but...

If DW inherits my Roths, they don't add to her taxable income (at her single tax payer rate) upon liquidation as would happen when she inherits (and liquidates) my 401(k) or tIRAs, right? SO, Roths would have another advantage over any other form of wealth transfer among spouses. Right? Or am I thinking incorrectly?

I think you are tracking. If RMDs ever go away or keep going up, Roth conversion strategies could change, depending upon one's legacy objectives. Good, bad, or indifferent, my priority has always been to "flatten the curve" as Fauci might say, staying in the same tax bracket until the dirt nap. I figure who ever is left standing as a single spouse will have $hit load of money so who cares if they pay more taxes. Also, I think my kids should look at inherited $$ (and there should be plenty) as found $$... that's how we trained them. Perhaps I will change over time, but right now I am focused on how mama and I can live on max net $$ over a reasonable life span.