More details of the GOP tax plan have leaked, and the new tax brackets look enticing (other than that we won’t have the funds to support infrastructure needs in the country) — on an individual level, even with the marriage penalty on the SALT deduction ($10k can be deducted per individual OR $10k per married couple), the actual brackets are promising in removing the marriage penalty for everyone except those who make over $600k as married filers. Continue reading
Since we’re not multi-millionaires (yet?) or owners of multi-national corporations, it’s unlikely the GOP tax plan (likely to pass in some incarnation of the House and Senate approved plans from earlier this month) will be good for us. Continue reading
As I mentioned in my recent post, I’m currently looking into what health insurance to select for next year. I have the options of Anthem HDHP, Anthem PPO, Anthem HMO and Kaiser HMO.
Typically, as a healthy-ish young adult, I’d select the HDHP. I’ve always been a proponent of HSAs, but now I’m not so sure – especially living in California, one of the two states in the country that doesn’t recognize HSAs as pre-tax income. It’s actually a rather complicated tax situation in CA that no one explains well… and I’m unsure if even I’ve been filing my taxes right with my HSA all these years!
What is an HSA?
An HSA is a supposedly tax-free account for healthcare costs. If you have an eligible health plan, you can contribute up to a certain amount per year (~$6900 for a family next year) which is put into the account pre-tax* and then you can invest that money and whatever it grows to you can take out tax free if used for qualified medical expenses at any point in your life. It sounds like a really good deal… and it is… except HDHPs have “high deductibles” and, even more troubling, HSA plans typically have very high fees that eat into any growth you see unless you are a wise investor (AND have access to good investing options, rare in typical employer-sponsored HSA accounts.)
*HSA Rules in California
What makes matters worse, California (and New Jersey) doesn’t recognize the HSA at all. So, any money you put into it is taxed as income. That seems to be handled automatically via the W2, since the employer makes those contributions on your behalf. But then you also (and I didn’t actually know this until yesterday) are supposed to pay taxes on dividends and any interest earned in the account annually. My HSA account is relatively small (it’s now about $7000) BUT I have to go back and amend returns likely if I have any earnings on the account each year. I did actually merge two accounts which, since both accounts did not have the same funds, required selling all of my funds to roll them into the other account last year. I’m guessing that will hit my 2017 taxes — and I’m not clear yet if gains will be taxed as long term capital gains or income. Not one HR person has explained this or mentioned this in all my years working… probably because they aren’t allowed to give tax advice… but it seems like something they should mention.
“Depending on what kind of annual statement the financial institution sends out, it could be extremely difficult to figure out how much HSA income account holders should report on their California tax return each year.” – SF Chronicle
Yup. I don’t recall ever getting annual notices regarding my HSA account’s tax information. The good news is that now that I’ve transferred all of my old funds to HSA Bank, I at least will have my records in one place – for this year. Well, sort of. I have two months worth of HSA funds at my new employer – though I’ve heard they’re actually using HSA bank now and transferring to a new system. I should probably check on that, since I have no idea where my new HSA funds are at the moment. Next year it will be a different bank that apparently provides fewer investment options in “funds.” This may still be worth it for the federal tax savings (over many years, as a retirement health account) BUT it’s troublesome that California is refusing to provide the tax treatment that the rest of the country (except NJ) offers. This state really is an expensive place to live.
HSA Account Math, Family of 2 (Example)
Family Out of Pocket Max: $9000
Monthly Cost (Annualized): $1030(*with employer coverage and contribution)
Max Out of Pocket Family of 2: ~$10k
HSA contribution: $6900
HSA contribution, 3% growth, in 30 years: $16,748
Value of tax deduction, federal: $2415 (35% bracket)
Value of tax deduction, state: $0 (or, -$897)
So, you pay $897 (state tax) + $5650 investment + $10k today = $16547 to have $16,748 in 30 years (*WITHOUT FEES ADDED)
(someone please check my math.)
Now, that doesn’t really work either – because unless you’re invested in TIPS (treasury funds that are tax advantaged), you’ll be taxed on any dividends earned by that investment every year, like it was a taxable account, for state purposes only. That will cut into your growth a bit.
Then, you also have to pay HSA bank fees, which are very high and also cut into your “savings.” Example fees include:
- Maintenance fee and Service Fee: $66 per year (if your bank account balance / non-invested funds – is under $5000)
- Monthly Investment: $21.00
- Using your HSA Card: $2 per transaction (!)
- Access Funds Through Internet Withdrawal: $2 per transaction
In any case, I’m not sure I know enough to call the HSA a sham, but it sure looks like a way for the bank to charge a lot of fees. And, just like any other screwed up government-created account (screwed up due to people in government not agreeing on anything and not giving a shit about the people of this country), the HSA which is supposed to be this brilliant tax free way to save for future healthcare needs is ACTUALLY just a way for banks to make money off of people who likely don’t even realize it.
It’s pretty crazy that there is a $2 fee to even use funds in the account EACH TIME YOU TRANSFER FUNDS OR USE YOUR CARD. This administrative fee might be necessary to cover the cost of running an HSA account, but if that’s the case, is it even worth it?
Now – if you can invest the funds in the market and do better than 3% a year, it gets a little more interesting. Still, because you’re investing in the market, what goes up can come down. As a long term investment it’s probably safe – which is why young people are wise to consider HDHPs and HSAs. However, none of this is discussed in open enrollment meetings. AND, most people consider an HSA just a larger FSA, and put their money in the account pre-tax and then spend their funds down over the course of the year. While there’s nothing wrong with this, per se, you are now paying $2 per doctor’s appointment to use your card. If you go to the doctor a lot, let’s say 20 times a year per family, you just spent $40 on going to the doctor in fees. For someone in a lower tax bracket who isn’t seeing that much in tax savings via a HDHP (since you only save the money from your top tax bracket), it may actually be a scam.
Let’s not forget that in the event of death, your HSA is taxable to your heirs entirely as income at their income tax bracket. While it can be used to pay off qualified medical expenses of the person who died and owned the account, anything left over is taxed as income. However, after 65 an HSA account owner can take out funds for non medical expenses without a 20% penalty. BUT, those funds will be taxed as income, just like a 401k.
So as much as I’m tempted to go the HDHP route next year (assuming we’ll spend the full $9000 out of pocket max) just to get those $6900 in federal funds in to an HSA pre tax, I’m really not sure it’s worth it.
PPO Costs in Comparison…
Family Out of Pocket Max: $5k
Monthly Cost (Annualized): $3k
FSA contribution (*is recognized as pre-tax in CA) = $2650 ($1272 tax savings)
Total Costs including FSA savings: $6728
PPO vs HDHP Costs Today
PPO: $6728 ($9819 remains to invest in post-tax accounts)
HDHP: $16547 (*includes $6900 investment)
PPO vs HDHP investments in 30 years (at 3% interest) – WITHOUT FEES ADDED
IF USED FOR QUALIFYING MEDICAL EXPENSES (TAXED OR NOT TAXED)
PPO: $19945 ($3937 in cap gains tax, CA)
HDHP: $16,748 (minus fees and state taxes – which could be significant over the years)
So, if my math is correct there, the PPO actually ends up being the BEST plan long term anyway, with taxable investments, at least in the state of CA (and probably in other states, although it might look a little better without state tax.
What About if I Don’t Hit My Out of Pocket Max?
Ok, so for arguments sake, let’s look at a more typical HSA scenario. You’re a healthy 20 something with 40 years until retirement. As a single person you can put $3450 into your HSA. You’re smart, so you plan to invest this month over the next 40 years vs spending it from this account. You have a HDHP and your annual out of pocket plan cost is $840. Your employer contributes some money, let’s say $1000, so you’re already ahead, paying -$140 (*minus CA state tax, I’ll get to that in a bit) — so your annual costs are negative, before you start using your account.
You scrounge up the funds to put in the $2400 ($200 per month) into your account this year, which will be augmented by the employer’s contribution up to your max of $3400.
You don’t get sick often, so you don’t hit your medical deductible or out of pocket max. Let’s say you spend $1000 on a few office visits and blood tests due to a scare, but nothing major – no ER visits, no recurring specialist visits. So, now your total cost of healthcare this year is $2400 and you’re getting a federal tax savings on your $2400 investment (but paying state income tax on this.)
Your federal tax savings, since you’re in a lower tax bracket (in your 20s, we assume) is 15% (if you make up to ~$38k.) So your tax savings on this is $360 (if you make $38k-$93k, you’d save $600.) You still have to pay state tax on this income – let’s say that’s $3400*8%=$272 for the sake of simplicity.
So, adding up all the numbers with HDHP, $1000 medical spend and $3400 annual investment as per the rules above
Healthcare cost = -$140 (annual premium) + $1000 (medical expenses) + $2400 (investment) + $272 state tax – $360 tax savings = $3172
In 30 years (to compare to other couple above) you have:
HDP: $8252 – $3172 initial cost = $5080 (gained, as long as it’s used for healthcare)
Now, let’s say this same person used a standard PPO.
The math is tricky because we don’t know how the deductible and coinsurance will play out, but let’s say they have a $250 deductible but a higher monthly fee. It’s a $1080 fee for the year, but with the lower deductible instead of $1000 in healthcare spending, it’s more like $350 due to the low deductible and co-insurance.
Annual healthcare spend = $1430
But we’re not done yet…
Since this person didn’t spend $3172 on healthcare this year (including the $3400 investment), they have $1742 left to invest in taxable accounts.
With the PPO, they have $4228 in 30 years at 3% growth ($2486 taxable at investment gains rates) = 2486-696 = $1789
With the HDHP, they have $5080 (gains) in 30 years at 3% growth
In this case, the HDHP appears to win (significantly.) Even if they take out the HDHP money for non healthcare use and pay the 20% fee in 30 years and income tax on this amount (Let’s say 25% income tax plus 13% state) = $2387.60 you are still ahead of the $1789 if you invested in a taxable account.
This isn’t taking into account HSA fees over the years, which add up and might make both worth a similar amount. AND you’re taking on the risk in the HDHP that you won’t need to use the full out of pocket max ($4500) which clearly makes the math reverse. Very quickly.
So IMO HDHPs and HSAs are only good for young, healthy individuals who have a low chance of needing to use their health insurance each year beyond a few routine doctors visits. Otherwise, I’m not sure they offer better savings than a lower deductible account and saving that money to put into the market. What isn’t covered here is that your investment options will be much broader in a non HSA account, and fees will be much lower (or at least you can choose if you want a higher fee account.)
Is all of that worth ~$600 in gains (per year) — which is probably more like $450 per year after fees? This is if you don’t use your actual health insurance much… one trip to the emergency room and your numbers suddenly won’t look so good.
This is why I’m leaning towards thinking the HSA is a scam for everyone. It’s too risky for the minimal reward you get for investing in it vs a PPO and investing any remaining funds in a taxable account.
Does anyone disagree?
It’s quite the luxury to fall pregnant the month of open enrollment. This means hubby and I can (theoretically) make smart financial decisions when it comes to selecting health insurance for next year which covers both the birth of our first child and their first six months of medical care.
Even with this great fortune, it’s unclear which of our options is the right one. Luckily, my company provides relatively good insurance. Given how much health insurance costs in this country, the $200-$300 we’ll be paying a month as a couple (and $200 to $400 as a family) is nothing compared to what insurance on our own would cost. Still, I want to make a smart choice here.
It’s hard to make smart choices when the data is all hidden. Plus, not every decision in life should be based on financial impact alone. Delivering a baby is serious business, and having the option to choose my doctors (especially in case anything goes wrong) feels, to me, like a must have. My husband disagrees.
As a “Kaiser baby,” he speaks highly of the whole Kaiser health system (which also happens to be our lowest-cost option by far.) While some people report Kaiser is horrible, it seems to be that they have their shit together in California. Still, it makes me incredibly nervous to switch to a new health system now with its own style of care.
According to the calculator provided by the open enrollment system — with maternity care and other costs this year (for family of 2) our Kaiser total out of pocket costs would be $3000 or less for the year, whereas Anthem PPO (low deductible) would be around $5000-$6000 and Anthem HDHP would be $8000 (but also includes a $6900 contribution to HSA pre-tax, so that’s about a $3000 discount long term if we buy and hold.)
Financially-saavy me thinks — go for Kaiser — it’s clearly a lot cheaper and it’s not bad – just different. People who dislike Kaiser seem to have rare medical conditions that the organization doesn’t find fast enough since they have no incentive to spend more money on your health, and you have to advocate for yourself. Their maternity situation actually seems to be well regarded. It might not be a horrible idea to go to Kaiser and save $2000=$5000 next year. Lawrd knows we’ll need it for daycare* (more on that in another post.)
Before I was pregnant, I found an ObGyn who looks great (lots of 5 star reviews online) and she didn’t have an opening until January so I booked it a while ago. I planned to talk to her about infertility but now that I’m pregnant, it works out that it’s week 10 of my pregnancy and likely ok to be my first prenatal appointment (I’m assuming — especially since my Reproductive Endocrinologist provides ultrasounds and bloodwork until I’m turned over to the Ob.) I’m just not sure if that trade off is supposed to happen at 8 weeks or if 10 is ok… but I’ll find out.
So… I’m leaning towards Anthem… even though it’s a waste of money. If we start with Kaiser now, we’re stuck (I’ll have a pediatrician selected for my child through them, and unless that doctor is horrible, we’ll likely want to stay with that pediatrician for our child’s entire… childhood.)
Regarding the Anthem options – I’m torn between the HDHP and the PPO. The PPO is cheaper, according to the calculator, and for my husband it’s nice that it has a $250 deductible. The monthly cost is definitely higher and doesn’t include any company contribution, so that’s why it starts to even out. Then the HDHP has that HSA which I love so much, being able to invest nearly $7000 in pre-tax dollars in an account we can invest in and use for healthcare later in life. That $7000 invested over 10 years at 5% would be worth $9.4k – $2.4k back, plus the $3000 or so savings in taxes up front, which is $5.4k, which covers the cost of the difference between this plan and Kaiser. And that’s with 5% growth and only over 10 years. So is Kaiser really cheaper? — That said, we’d have to pay $7000 up-front now out of our take-home income (though it would only feel like $3500 lost, comparable to the Kaiser costs, I think?)
Either way, I’m fortunate to have a job that pays well enough to be able to be able to decide on this. Keeping my job has never been this vital, and every day I step in the office I know I have to get my game face on and make this work. Somehow. I haven’t told my boss yet that I’m pregnant (one doesn’t do that until week 12 or so, apparently), but I’m nervous about sharing this news with him since I’m not covered by FLMA until 3 months after giving birth to my child. More on that, later…
Getting married is wonderful for so many reasons. Taxes is not one of them. Besides the horrific marriage fine levied by our tax lords if you happen to want to be an independent woman and continue working post tying the not, there’s also a whole host of tax intricacies which suddenly make TurboTax no longer a viable option and accountants your new BFF.
My husband is an independent contractor. He usually makes anywhere between $80k and $110k per year, depending on how business is going. As a single person, he was able to take advantage of safe harbors designed to protect self-employed folks from overpaying taxes to avoid fines for coming short on estimated tax payments.
Safe harbors for estimated taxes for single, self-employed folks basically say that you can either pay 90% of your current year’s eventual tax bill OR 100% of your prior year’s tax bill. As a single person, this is pretty easy to figure out — even if it’s hard to guess what 90% of this year’s tax bill will be, you can pay 100% of your prior year’s tax bill and know you’re safe from fines, even if you end up owing more at the end of the year. If business isn’t going quite as well this year, you’ll get a refund, and you’ll give uncle sam a loan for a while, but it won’t be that bad.
Of course, getting married makes this all sorts of more complicated, requiring expensive accounting help to make sense of this mess.
Estimated tax safe harbor for higher income taxpayers. If your 2016 adjusted gross income was more than $150,000 ($75,000 if you are married filing a separate return), you must pay the smaller of 90% of your expected tax for 2017 or 110% of the tax shown on your 2016 return to avoid an estimated tax penalty.
Thank you IRS for an explanation that is not clear at all. It sounds like if your AGI is over $150k as a single OR married person you are considered a higher income taxpayer. This means Mr. HECC would not have been considered a high income taxpayer as a single person, but now that we’re married we’re well over $150k and he can no longer use the safe harbors for his estimated taxes.
Instead, we have to pay 110% of our 2016 taxes (including my taxes) in order to not get penalized this year. Suddenly, my W2 withholdings are no longer an annoyance of over or underpayment to the government, but they can result in substantial penalties.
So – we need an accountant, stat. I consider myself fairly financially literate and the IRS explanation of all of this is the most confusing thing I’ve ever read.
Are any of you married with one partner earning W2 income and the other self employed? How do you manage your estimated tax payments?
There is a lot of misinformation about the marriage tax penalty. While it’s true if one spouse doesn’t work and the other makes any amount of income, the couple will get a “marriage bonus,” once both partners are working and making enough income to live, esp in a high-cost-of-living area, the tax penalty is going to kick in.
The worst marriage penalties are seen when you have kids and lose deductions based on income, but I’m going to share in simple terms why we received a marriage penalty this year – this beautiful first year of our marriage – due tour income.
Federal Taxes Only (State marriage penalty not included below)
Single Filer Tax: $47,749.25
Single Filer Tax: $22381.75
- Total Couple “Single” Federal Tax: $70131
- Married Filing Jointly Tax: $74,217
And, just in case you’re wondering, it is not better to “file separately” as a married couple — this is not the same as filing single (which you can’t do when you’re married.)
Married Filing Separately:
Single Filer Tax: $51,958.50
Single Filer Tax: $22981.25
Total Married Filing Separately: $74939.75
As you can see, if you have somewhat higher incomes, the marriage tax penalty will be quite notifiable.
If we never got married… $70,131 in taxes
Marriage Fine (Filing Jointly) +$4086
or, Marriage Fine (Filing Separately) +$4808.75
This plays out similarly in state taxes.
Yes, we’re fortunate enough to be high-income earners – but we also cannot afford a house. So there’s that.
My boyfriend and I have been dating for over eight years now and we’re seriously discussing marriage. I’m not sold on the whole marriage thing — I don’t believe one needs to be contractually committed to another person to have a lifelong partnership and a family. It seems that with all of my passionate hatred of organized religion and government getting involved in social freedoms I should not be considering getting “actual” married. Sure, a small ceremony would be nice, but the legal side of it frightens me quite a bit — especially since so many people I know who are older are divorced and worse off for it.
While I don’t at all expect to get divorced ever (hey, we’ve made it almost nine years as bf/gf and if we do get married it will be on our 10 year anniversary – by then I think I’d know what I’m getting into) I still don’t know if marriage is a good idea, financially speaking. The way marriage is set up… and the tax laws around marriage… is that you are rewarded for having one working parent and one stay-at-home parent. If you have two working parents and earn reasonable salaries you actually can have what they call the marriage tax penalty. Before tying the knot, I really want to better understand if that is going to cause a fiscal knot in my future bank account.
After writing this post, I found this awesome breakdown by Financial Samurai which details out the tax benefits or penalties for different types of married couples — it is a must read!
How Marriage and Tax Works
Starting the year you get wed you are officially a married couple in the eyes of the government — even if that happens on the last day of that year. You have a choice now to file married jointly or married separately. If you and your partner both work and make equal salaries, unless you’re low earners like teachers or social workers, you’re going to probably be better off filing separately.
The problem is — married filing separately doesn’t actually mean the same thing as filing as a single person. If you file separately while married you cannot take deductions for tuition fees, student loans, social security benefits tax-free exclusions, credits for the elderly and disabled, earned income credit, hope or lifetime learning education credits, child care credits, etc. And if you decide to file separately and one partner wants to itemize, the other partner needs to itemize their taxes too, even if they have no reason to do so.
But the bigger issue is for higher income earning couples. As you can see below, married filing separately and single filers do not have the same tax brackets. If you are married filing separately, anything over $74.4k will be taxed at 28%, where if you are filing single you have until $89.3k before you are bumped into the 28% tax bracket. If you happen to earn more than $180k per year as a ginle person you’ll still be within the 28% tax bracket, but if you’re married filing separately you’re going to pay 33% for any income over $113.4k.
Of course if one parent works and the other doesn’t the tax table works in that couple’s favor. I.e. say I work and make $200,000 per year and my husband stays at home and makes sure that the kids eat and don’t die — filing jointly we could remain in the 28% tax bracket, whereas if I were filing single and not married my top income would be in the 33% federal bracket.
2014 Tax Brackets (for taxes due April 15, 2015)
|Tax rate||Single filers||Married filing jointly or qualifying widow/widower||Married filing separately||Head of household|
|10%||Up to $9,075||Up to $18,150||Up to $9,075||Up to $12,950|
|15%||$9,076 to $36,900||$18,151 to $73,800||$9,076 to $36,900||$12,951 to $49,400|
|25%||$36,901 to $89,350||$73,801 to $148,850||$36,901 to $74,425||$49,401 to $127,550|
|28%||$89,351 to $186,350||$148,851 to $226,850||$74,426 to $113,425||$127,551 to $206,600|
|33%||$186,351 to $405,100||$226,851 to $405,100||$113,426 to $202,550||$206,601 to $405,100|
|35%||$405,101 to $406,750||$405,101 to $457,600||$202,551 to $228,800||$405,101 to $432,200|
|39.6%||$406,751 or more||$457,601 or more||$228,801 or more||$432,201 or more|
This all seems like marriage isn’t the best idea unless I plan on remaining unemployed and being a gold digger the rest of my life. It’s hard to know what the future holds, but the reality is that marriage might not be the best idea financially speaking. In fact, if I get married it will be likely that my husband and I will each earn around $130k AGI each, or more. If we earn $260k jointly we are in the 33% tax bracket. If we each earn $130k and file separately we are also in the 33% tax bracket for every dollar earned over $113k. BUT if we weren’t married at all and earned $130k all of our income would be in the 28% tax bracket.
Am I missing something here, or is marriage just a big scam to get us to pay the government more of our hard-earned money?
This article seems to make the case that marriage isn’t worth it — unless you plan to have only one working partner or both be very low income earners.
Some Other Items to Note
- BONUS: You can get joint health insurance if one partner has it through work… this isn’t a tax benefit but it is a benefit to being married.
- PENALTY: The Child Tax Credit provides up to $1000 for every child under 17 in one’s care, but if you file a joint return the credit phases out at $110k income total for both partners. If you file separately you don’t get the credit at all. If you are not married and file single it phases out at $75k (**again a reason why this should be determined based on cost of living because $75k is a large salary in some areas of the country and in others it’s not enough to afford a basic lifestyle.)
- PENALTY: Miscellaneous deductions can lower taxable income, but they need to add up to more than 2% of AGI to actually matter. If one spouse has these deductions but the other doesn’t, it can be a big headache since both spouses have to itemize if one does. That also can cost more to prepare since it’s no longer standard TurboTax click click and done.
- BONUS: If you’re married and own a home with your partner, you can take $500k in gains tax free when you sell for your next house. If you’re single you only get to take $250k in gains. That said — most of us won’t have more than $250k gains on a property because we’re buying houses that at most are $1-$1.5M. Aimirite?
- PENALTY: Obamacare requires an additional 3.8% tax on net investment income when gross income exceeds $200,000 at a single tax payer… BUT $250k as a married couple. So basically if you earn $125k each (totally normal in cities like San Francisco or New York) you are going to pay a lot more on your investment income. Being single and making under $200k is a lot more reasonable.
- BONUS: If you are married you can give each other as much money as your heart pleases because you basically now are the same person. If you happen to die unexpectedly, god forbid, your partner can get all your monies tax free. This is the one true bonus of marraige left but does it outweigh the extra taxes paid annually as a married couple? (Otherwise I’d think you could just get married later in life once you are ready to take advantage of tax-free cash sharing.)
- PENALTY: This also provides a strong incentive for your partner to hire an assassin to make you disappear, if you happen to be the keeper of said monies (or maybe I’ve just been watching one too many episodes of law & order)
- PENALTY: To deduct unreimbursed medical expenses they must be more than 7.5% of your AGI. If one partner has a big surgery that costs a lot and cannot work during the year — and is single or filing separately — he can take that deduction. But if the couple files jointly and the other partner makes a lot more then the deduction is harder to obtain.
- PENALTY: If you make more money, more of your Social Security is subject to tax. You’re better off filing single vs married to keep more of your SS benefits. Also if you are a couple with two working partners — you’ll end up with more social security in the long run if you remain single!
- PENALTY: The AMT (Alternate Minimum Tax) exclusion for two unmarried individuals is much lower than that for a married couple, and this can cause upper middle class earners thousands of dollars in extra tax each year.
- PENALTY: If one partner earns less money in one year than another, if the couple remains single filers one person who earned more money can gift the other up to $13k in appreciated stock, tax free, which she could sell at her capital gains tax rate (which could be 0% if she is not earning anything that year, but filing jointly at that point might actually save the couple more.)
- PENALTY: A single person can deduct up to $3,000 in capital losses per year. Married couples… can only deduct up to $3k in capital losses (not $6k.)
- PENALTY: If a couple is unmarried and, say, the woman owns a house in her name and the man gets sick and relies on Medicaid to pay for a nursing home, Medicaid cannot come after the house that the woman owns. However if they are married they can take the house away!
- PENALTY: The Roth IRA contribution limit for a married couple is lower than it is for two single individuals! If you’re a single person you can invest $5500 per year in a Roth IRA if you earn less than $114k per year (AGI) — BUT — if you’re married, you can only earn $181,000 jointly to invest in a Roth. That’s $47,000 less income you can earn and still be eligible to invest in a post-tax IRA account.
- PENALTY: Write-offs from rental real estate can be used to offset ordinary income unless your AGI exceeds $150,000. That is — $150k as a single person or married — that amount is the same!
One of my readers, Jake, posted a thoughtful response to my post 10 Tax Breaks Only the Rich Enjoy noting that my explanations were factually inaccurate. I thought he had some really good points, so I wanted to address each below. I also want to clarify that I do not necessarily have anything against rich individuals who worked their way up to obtain wealth. The problem is that once a family has money they can maintain that money within their family for generations, with many “trust-fund babies” not having to earn their wealth. Also, I have a problem with tax loopholes that are designed to only benefit the wealthy yet that are useless to the middle class.
(Side note: I think that federal and state income tax should be adjusted for cost of living per county. It is obscene that a San Francisco household should have to pay the same effective tax rate to someone in Fresno where cost of living is much lower. $300k in AGI for a married couple is a lot in many regions of the country and in others it is squarely in the middle class. Thus, income tax brackets should be adjusted for cost of living. I’m not sure if this could work, but it would make a lot more sense then the current tax system.)
Jake wrote: “Sorry, but most of this applies to the 0.01% of income earners, not the 1%. Additionally, a lot of what you outline is misleading. I’ll address each section.”
While many of these tax breaks are most beneficial for the .01%, the .05% and yes even the 1% get more out of many of these tax breaks than people with middle class incomes. The super, super rich get the best tax breaks of all.
RE: The Rich paying 0% on Capital Gains Tax
Jake: I don’t know how you got 0% capital gains tax. Not only do the rich have to pay capital gains tax, but they pay it at a higher rate because of their income.
The really rich do not pay capital gains tax at a higher rate. How can this be? Most people who aren’t extremely wealthy have to work and work for pay. When we work, we generate income. This income is what defines our capital gains tax rate. The top capital gains rate for the wealthy is 20%. So how are some getting away with not paying any capital gains tax?
The super rich do not need to generate income. If an investor is in the 10% and 15% tax bracket for income, then s/he pays 0% in capital gains tax. This means that if someone has enough money to sustain them via investment growth and dividends, s/he never has to earn income and can stay in the lowest income tax bracket, thus withdrawing any dividends and gains on investments at a 0% capital gains tax rate.
Thus, my point is that capital gains tax rate should be the same for everyone, not based on income levels, so that way no one can cheat the system.
RE: Mitt Romney paid just 15% federal income taxes despite making way more money than someone in the top brackets
Jake: Yes, Mitt Romney paid 15% in federal income taxes, but most Americans making 50-75k paid 7.8%. Someone that makes 100-200 paid 12.1%. The kicker? The bottom 50% of income earners paid 0% in income taxes. It puts Romney’s 15% in context. These are facts.
This isn’t about the bottom 50%. Yes, in our society people who make money pay tax to support services for people who are unable to make enough money to live, true. But the actual problem here is not about the bottom 50%. It’s the fact that the middle class is disappearing due to loopholes like this only available to the super rich. If you make $100,000 a year (single filer) you will pay 21.18% of all of your income to federal tax. If you make $200k, you’ll pay 24.93% of your income to federal tax. At $300k a year, that’s 27.62% to federal taxes. But if you’re super rich and in one of these jobs where the loopholes are available, you can pay much less while earning much more.
RE: Home deduction tax benefit is much better for the rich than the middle class
Jake: “Yes, the rich enjoy the home interest deduction along with 67% of America. The rest of Americans can also deduct the full amount, while the PEASE limitation reduces the amount that the rich can deduct.”
True. However, the way taxes work, the wealthy are getting a much bigger benefit to purchase property over the middle class. If the wealthy haven’t taken advantage of the former loopholes, basic math tells us that the deduction for the rich is going to be greater than that for the middle class. “One of the unfortunate and largely unintended effects of structuring tax benefits as deductions or exclusions is that they tend to provide much bigger tax benefits to those in the highest tax brackets. For a wealthy taxpayer in the highest tax bracket—now 39.6 percent—a $10,000 itemized deduction, such as one for mortgage interest, results in $3,960 in tax savings. For a taxpayer in the 15 percent bracket, however, that same deduction is worth only $1,500.” (source) Yes, the PEASE limitation is helping this a bit, but the mortgage interest deduction still percentage-wise much greater benefits the wealthy over the average middle class person.
RE: Giving to charity to preserve family wealth
Jake: “This just doesn’t make sense. How can you knock giving to charity?”
Answer: Because “giving to charity” is not always actually giving to charity. For example, the Walton family, heirs and heiresses to the Walmart fortune, are using this loophole very smartly to preserve their wealth over generations. With a fortune worth $115.7B, the family is set for at least a few generations, and tax laws help them ensure this.
How is this possible? The Waltons and many other super rich families use a charitable trust that allows the donor to pass money on to heirs after an extended period of time without having to pay estate tax! If a donor locks up assets in charity trusts (CLATs) for a long period of time an amount set by the donor is giving away each year but whatever is left goes to a beneficiary TAX FREE. Just one of the charitable trusts would result in $2.2B for Walton heirs, without owing any tax on it. (source). While most people won’t have to pay estate tax anyway (your estate needs to be worth more than $1M before estate taxes begin to be levied), it is the super rich that the estate tax is designed for – to ensure that people aren’t just living off their family’s wealth and never paying a cent to support the government or working a day in their lives.
RE: Deduction for private jets
Jake: ‘Not many 1%’ers own private jets. That’s for corporate CEOs, professional atheletes and entertainers….many of the 0.01%”
True. This is probably relevant only to the top elite only. Nonetheless, it’s still a tax break the super rich enjoy.
RE: Fake-Out Agricultural Tax Credits
Jake: Anyone who owns a home can do this (67% of America), not just the 1%
Each state has its own rules on how individuals who own property can take tax credits for agricultural use. The point is not whether anyone who owns a home can take these credits, but how the credits are much more valuable for people who own expensive homes and properties. Another example of this – in NJ, fake farmers are costing the state millions of dollars. The Farmland Assessment Act of 1964, intended to preserve agriculture in NJ, is being used by millionaires, developers and anyone with at least five acres of land to slash their farmland tax bills by 98% — all they need to do is produce $500 in goods per year to qualify for tax breaks. For instance, one person used a cow to eat the home’s front lawn for a few months and then sold the animal, enabling the individual to take the tax break on their five acres. Even Bruce Springsteen takes this tax credit. While he pays $138k a year in taxes on his own home, he owns an additional 200 acres which he has a farmer come and grow a few tomatoes so he doesn’t have to pay a lot of tax on this land (only $4639 per year.) (source)
Thus this tax loophole doesn’t benefit 67% of America who own property, but only the super wealthy who own more than five acres of property (rules vary per state but generally this is designed to help the super rich fake farmers only.)
RE: Rental Property Tax Benefits
Jake: Anyone with a rental property can do this type of exchange, not just 1 percenters.
Again, you’re spot on Jake. Anyone can take advantage of the tax loophole which enables them to purchase rental property and do a like kind exchange to trade it for property worth the same or more without paying taxes. Now, only the rich can afford to do this enough for it to make a big difference. For example, as someone with $300,000 networth, I invest in real estate via REITs. When I sell a REIT I must pay capital gains tax on this REIT, even if I want to purchase another REIT. I cannot just trade this without paying any tax. Also, I could own rental property and do a like kind exchange, but with $300,000 total in networth I’m not going to be able to purchase enough property for this to really help. Since wealthy real estate investors can do this over and over again (there is no limit for how many times they can trade property without paying tax and taking deductions for depreciation of their owned properties on sale) in the long run they will only pay capital gains rates on the property sold last.
But if you’re really rich, you never have to sell this property when you’re alive! You can pass this on to your children tax free. The basis which your children will pay tax on upon sale of the asset is determined not by how much you paid for the property in the first place, but instead how much it was worth on the day you die. Assuming you were a very smart investor and used like-kind trades throughout your life, you could have significantly grown your real estate value over time, enjoyed depreciation deductions, and then pass on the property tax free to heirs who can sell it for the amount it’s worth on the day of your passing. Most people cannot afford to keep so much of their networth locked up in investment property, but the super rich can.
So, Jake, as you see, much of my points have to do with how these tax benefits mostly help the super rich. This may not be the 1% but at 1% you start to experience some of these benefits. Once you have a certain amount of money in your family, though, you can maintain it for many, many generations through these loopholes.
Ahh, what’s that smell? American Greed?
We 99%ers love to call out the 1%. Some get to the 1% with hard work and luck, but many are placed there due to being born into privilege and likely a sizable inheritance. Others weasel their way into wealth. Few can get there in a way that wouldn’t make some “kooobaya-type god”scream mercy. Regardless of how the 1% made it to the top of the fiscal food chain, they can enjoy a whole host of benefits staying there — private jets, beautiful women, more beautiful women, houses, yachts, and — last but not least — some really tricky tax breaks so they can just keep accumulating more and more wealth!
Here are 10 tax breaks that only the super rich enjoy. Read ’em and weep.
- Income Tax, Smincome Tax
The rich don’t need your stinkin’ income. CEOs can come out and say they’re going to take a $1 salary and the masses think that they’re being just so damn humble and giving. Not so. While us lowly folk have to work and get paid salary to do things like eat and have a roof over our heads and pay for our kids piano lessons, the rich can take their heaping savings and put it into investments that compound over time. Good thing these folks are not actually earning any income because that means they can enjoy 0% tax rates on all of their capital gains. The best us lowly folk can do is attempt to put together an investment plan that eventually provides us with enough dividends and capital gains to also take out our money tax free, even if we never have an army of beautiful girls/men and/or private jets (source)
- Taxes Are for Losers (AKA Poor People)
Some rich folk work in fields like investment banking, private equity management, or real estate partnerships. Not only do they get paid a lot off the bat for these roles in terms of total compensation, their pay is not in the form of that same lowly income you and I see deposited into our bank accounts every few weeks. These modern-day royals get to be paid in a “carried interest” which is – somehow – usually taxed as a capital gain instead of ordinary income. That means these richies are paying 20% taxes to the federal government on all of their earnings. Even Mitt Romney managed to pay 15% taxes for his great service to our country as head of Bain Capital (yea, aren’t you glad he didn’t become our president?) (source)
- Home is Where the Cash Is
The government wants to encourage home ownership because this means the country is more stable, generally speaking. Thus, big brother provides tax incentives for home owners of all wealth levels (as long as you can afford a house.) However, the best writeoffs go to the super rich. The mortgage interest deduction lets taxpayers who itemize deduct the interest they pay on their home mortgages. The way the program is set up, the more expensive the home and the higher the homeowner’s tax bracket, the bigger that subsidy is. (source)”Less than one-third of taxpayers are able to take advantage of the deduction—it is restricted to those who itemize their deductions, a group that skews toward the upper end of the income distribution. Also, the benefit is tied to the marginal tax rate of the taxpayer and so has higher value to those with higher income. For households making above $200,000 a year, the average benefit is $1,784 a year in tax savings. For households earning $65,000 a year, the deduction generally yields less than $200 in tax savings.” (source)
- That Foggy Definition of Charity the Rich Love
Oh, what wonder, a 1%-er is donating something to charity. That’s great, if genuinely done to help an organization, but often the reason for donation is not exactly out of good will. It’s horrible to say but many charities are corporate scams. Seriously. Let’s take a look at Walmart. The Waltons, owners of Walmart, are using “Jackie O” trusts to both give money to charity AND pass on money to future generations without paying estate taxes. Oh, and did I mention they’re doing this all through their own charity, The Walton Family Foundation? This is perhaps more disturbing than the other tax loopholes because wealth dynasties are why inequality is cemented into American culture. (source)What’s more, “generally, you can deduct the fair market value of property you donate to charity if you’ve owned it for more than one year and the property is used to further the charity’s tax-exempt function. Thus, the appreciation in value is untaxed forever. The tax law limits the annual deduction for gifts of appreciated property to 30 percent of AGI, but that still provides a gaping tax loophole.” (source)
- Beam Me Up and Around and Around Scotty
Geez, private jets are just so damn expensive. But how else are the rich supposed to get from point A to point B? Not with the underlings, by god. There is a special subsidy for corporate jets which cost taxpayers $3 billion a year. Yes, a common tax trick and CEO perk is to pay for private jets under the guise of security (because what if a poor average flight attendant accidentally spilled coffee on their Prada suit during a turbulent flight???) If a benefit is classified as for security purposes the CEO will pay a reduced tax bill or no tax at all on the bene. (source)
- Mooooooooooooooooooooooooooooo. Mooo. Mooooney
I feel like we should just let this tax write off slide for the sheer fact of it being so ridiculous. JK. This will make you want to go tip some cows. In states like New Jersey, Florida, Texas, Iowa, Colorado, Alabama and more, farmers can take a tax deduction for their service feeding our great nation. That is, even farmers that aren’t farmers at all. According to an article in The Nation, that’s what Michael Dell did with his second home—a suburban ranch in Austin. Because he hunted there periodically and maintained a “well-managed deer herd,” he was able to reduce the property’s 2005 market value from $71.4 million to an agricultural value of $290,000. That saved Dell—but cost Texas—$1.2 million. Florida has a well-known “rent a cow” program (I kid you not.) What is this cow business? To qualify for the tax writeoff, Florida requires a couple of cows or a herd of goats, which don’t have to be on the property all the time. So you have wealthy people paying next to nothing on property tax because they own lots of acres and can afford to rent a few cows. (source)
- John Edwards and Newt Gingrich Walked into a Bar (and didn’t pay any tax)
This one is a doosey and surprise surprise it involves politicians again. Slime of the earth. Payroll taxes are supposed to be paid on income from work, with social security payroll tax paid on the first $113k in earnings (as of 2013) and medicare payroll tax paid on all earnings. Except S corporations, which are made up of a partnership of self-employed type folks, don’t need to qualify all their earnings as payroll, and thus it doesn’t need to be taxed. This one gets a bit complicated to explain, so just check out this writeup to get the full picture of how dishonest richies can get away with legal tax loopholes that only benefit the 1% (source)
- Newt Gingrich: In 2010, Gingrich Holdings, Inc and Gingrich Productions paid Newt Gingrich$444,327 in wage income while declaring $2.4 million as profits of the S corp. This allowed Speaker Gingrich to avoid $69,000 in Medicare payroll taxes. [Wall Street Journal Market Watch, 1/23/2012]
- John Edwards: Senator Edwards earned $26.9 million from his work as a trial lawyer in 1995. He paid himself a salary of $360,000 each year for four years and took the rest as distributions from his S corp. This saved Senator Edwards an estimated $600,000 in payroll taxes. [New York Times, 7/10/2004]
- Selling a House and Paying Taxes? Yea, Right.
Even average American homeowners can take $250,000 of their home price increase tax free ($500,000 for married homeowners) which is a pretty good deal after years of fixing broken air conditioning systems and having termite genocide parties. But the real tax benefit for housing is only available to the super rich (surprise!) A 1031 Exchange, also called a like-kind exchange, enables real estate investors to trade the equity in one property to another property of equal or more value without having to pay taxes (yes, you heard me right.) The taxes will need to be paid eventually, but the investor, in the meantime, gets to reallocate their portfolio and you can still take a depreciation tax write-off on your properties that are being exchanged. There’s no limit to how many times you can do a 1031 exchange. Since the rich are doing this with their real estate investment property (you can’t do this with personal property, sorry 99%), when they do sell it eventually they’ll sell at the capital gains rate. (source)
- Tax Breaks (i.e. Itemization) Seriously Favors the Rich
There are many different tax deductions available to take. But, of course, in order to take a deduction, you must itemize your taxes. While itemizing makes financial sense for high-income Americans, it does not for low ones. This means that deductions are mostly utilized by the rich. Only about one-third of Americans itemize their deductions, and they are mostly the well off. In 2010, only 29.3% of those making between $30,000 and $50,000 itemized, but 96.8% of those making $250,000-plus did. (source)
- One Home is Just Not Enough
Speaking of itemized deductions, owners of two homes get to write the mortgage of their second one off as well, as long as they itemize. It turns out this tax benefit isn’t for folks who own tiny little vacation bungalows by the shore or middle-class lakeside cabins. Nope, the main benefactors are the super wealthy. Just to rub salt in the wound of us reg’ies, rich folk can DEDUCT THE INTEREST PAID ON THEIR LUXURY YACHTS (fyi that clink-clanking you hear is the sound of me kicking all the buckets in the world.) As long as these boats are equipped with sleeping quarters, a kitchen and a toliet they can deduct the mortgage debt on these “homes.” (source)
As I’ve been running calculations on whether or not it makes sense to do a Roth Conversion, I came back to the question — what will my effective tax rate be in retirement?
That’s a question a lot of us considering a Roth Conversion should ask, but it’s not one that is easy to answer. What’s important, though, is that the numbers you plug into your calculations are reasonable. After all, expecting a 40% income tax in retirement each year can greatly skew your calculations if in actuality you’ll see a 20% effective tax rate.
This Forbes article by Erik Carter was really eye-opening: Why Your Taxes in Retirement May Be Less Than You Think
- You are probably overestimating what you will have to pay in taxes at retirement
- Withdrawls from Roth accounts are tax-free at 59.5
- Social Security is taxed at ordinary income rates but only part of it is taxable
- Long-term capital gains are taxed at lower rates than income tax (*at least according to current tax law)
- Your income will probably be lower and put you in a lower tax bracket (i.e. experts recommend 80% of your pre-retirement income, but you may need less)
- When you are older than 65, you get different deductions than younger people. For instance, you have a $1550 higher standard deduction than us young folk
- A lot of 401k contributions withdrawn yearly will be taxed at lower rates, especially if you plan on taking out less than $36k per year (note, that’s no where near 80% of my current salary, but I could live on it in another state if I owned a house free and clear)
- Tax rates could be higher when you retire but that’s unlikely (*not impossible)
- Lots of people retire in states that don’t have income tax like Texas, Florida and Nevada. (*check out this handy-dandy state income tax calculator and weep… unless you live in a state with low income tax.)
- Move where all the old people live and you’ll be fine.