Rich Explains Why High Income Earners Feel Woozy At Tax Time. He Pays 9 Times More in Taxes Than Penny.

Why does the rich guy always look like a creep?

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Penny —

Tax time. Blows. Chunks.

Well, I can be a little more descriptive than that.

It blows big chunks of regurgitated money vomit. 

Puke is a good description, because it’s eating something, tasting its goodness, and then spitting it up into a complex system of pipes. Maybe it’ll end up being recycled for a good purpose somehow. That’d be nice. But from my perspective, it goes down the drain and leaves me wanting to brush my teeth.

Feels better to get that out, doesn’t it? Here’s the truth: I actually don’t mind taxes. I’d rather have a decent income and pay taxes than to be homeless and pay no taxes. And, I appreciate (rationally, if not emotionally) the good that comes from taxes. Roads. Fire Stations. Aircraft Carriers. Food support. You know, the good that flows to my fellow squirrels from the Central Oak and all that.

I actually wouldn’t mind if my taxes were used a bit more for the common good of society — for more affordable health care and social services and universities, a la Europe. But that’s just me.

Penny, you’re in an interesting spot right now, right between poverty level and self-sufficiency level, according to the tax code. You wouldn’t want to earn less money, for obvious reasons, but earning more money means you’ll lose some of the benefits of our tax system. You’ll need to earn even more to experience a real financial benefit from earning more. Ironic.

Welcome to the middle class and the joys of a progressive tax system, I’d say. But you’ve got a ways to go to really pay some tax. Here are your current numbers compared to mine, just for fun.

That’s a difference of $67,887 in tax money paid / received.

So I earn 5 1/2 times more than you in AGI, but pay 9 times more than you in taxes.*

[*Yes, I realize you pay zero taxes and any number times zero is zero, but the calculation is you’d need to pay back your $7,604 refund just to get to zero, and then pay $7,604 another 8 times to reach my tax liability.] 

I think Uncle Sam loves my family. We’re in the upper middle class tax paying sweet spot. We earn enough income that we can pay a ton of taxes, but we don’t earn so much that we can utilize the tax strategies and shelters of the truly wealthy.  

Every year for the past 5-6 years, I pay $7,000 to $9,000 in April when I file, even though I don’t claim any exemptions. I often look at this and think, “What am I doing wrong?” Nothing, really. Quite the opposite. We owe more because in addition to our salaries we earn extra money from investments. I’ll need to detail those sometime, but they consist of farmland and commercial real estate. In 2016, those investments grew by almost $30,000. 

Moreover, since renting is not encouraged as part of the American Dream, we don’t get a mortgage interest deduction. Uncle Sam would reward us for taking on a huge amount of debt for a house we don’t want … gee, thanks … but no thanks.

I’m being sarcastic but the reality is the tax system favors certain choices over others, doesn’t it?

It’s not that I don’t try to reduce our taxable income. We are not taxed on the following:

  • Our 401k contributions = $36,000. (I’ll be taxed on this when I use it in retirement)
  • Flex savings account for child care expenses (includes preschool) = $5,000
  • Flex savings account for health care expenses = $2,600
  • Total: $43,600 of income not taxed, saving me something like $14k in federal. I’m not an accountant — this is an estimate.

I do my own taxes using TurboTax. What I love about this program is it asks me questions to see if I’m eligible for a deduction. I’ll answer these questions dutifully, and at the end the software will say, “Sorry! Your income is too high to qualify for this deduction.” I just love that part. Thanks for wasting my time, TurboTax guy.

There are a few things we’re going to do to pay less in taxes over the next couple years.

  1. Contribute to a Health Savings Account. We’ll contribute $6,750 per year (the max) and ditch the health care FSA, because you can’t have both. That’s an additional $4,150 we won’t be taxed on.
  2. Contribute to a 529 college savings plan. We won’t need to pay State income tax on our contributions.

And you know what that extra tax savings will add up to?????

Drumroll ………………..

Not a heckuva lot. Maybe $1,500 per year. It will add up over many years, but it’s mostly a small exercise in making myself feel smart. It’s not going to change my life. For the rest of my working life, I’ll be paying a lot of taxes!

Feeling a touch of nausea,

Rich

8 Replies to “Rich Explains Why High Income Earners Feel Woozy At Tax Time. He Pays 9 Times More in Taxes Than Penny.”

  1. Rich, I have got to think here are ways to structure your investments , since they are real property, in a way to reduce your tax bill further. Perhaps you could structure the investment under some sort of company entity. Have you looked into anything in that area?

  2. Thanks FTF — at some point I’ll detail these investments, which are held in an LLC (I am one member along with my brothers). We own farmland, commercial real estate, and a portion of a small business. Together these entities produce regular, taxable income. There’s not much we can do to make the income tax free.

    I think the main reason I get hit on my personal income taxes is my wife and I are in a high income bracket. The only way to further reduce our taxes would be increased giving to charity, mortgage interest, or the HSA and 529 I mentioned above. If I’m missing something I’m all ears!
    Rich @ pennyandrich.com recently posted…Penny Is A Broke Gal Who Pays No Taxes. By Earning More, She Ends Up With Less!My Profile

    1. I was thinking is there a way to register as a s-corp instead of an LLC and keep the taxable income within the corp as reinvested in the near term. Admittedly I’m not an expert here.

      Without the S-Corp I might look at some way to get my ownership of those assets into a roth. I’ve heard of such setups though Im not sure how possible it is to do after the fact.

  3. I can feel your pain Rich! Tax time has become unpleasant the past few years. I have a post coming out soon about how taxes are perceived in general. Doesn’t sound like you have more room to optimize unfortunately. I also agree that the super wealthy have more opportunities to reduce the pain.

  4. I think the entire tax system is designed to sucker punch the middle class. The poor don’t pay taxes and neither do the rich (who can afford to hire lawyers that help with tax minimization). Thus, it’s the middle class that’s shoulder the financial burdens of society.

  5. I feel your pain Rich and Max Your Freedom.

    I just filed our taxes this past week and after having additional amounts held from my check for the last 6-months of last year, I still had to write a check to the IRS (well, I sent it electronically).

    Taxes got us for a goo $90,000 in 2016. And based on our projected income for 2017, we are looking at something closer to $130,000.

    I always tell people that taxes are a good problem to have, it means your making money. Rich, like you, I would rather pay a truckload in taxes, than the alternative.

    Cheers,

    Dom
    Dominic @ Gen Y Finance Guy recently posted…From Welfare to Well-Off: My Rags to Riches Story (in the Making)My Profile

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