This post is a bit of a rant that developed in my mind as I prepared myself to move onto a PPACA-compliant health insurance plan this year. I also have the wonderful blessing of a dramatically increased income this year. So in this post, I’m going to talk about a decidedly first world problem. Despite all the whining I’m going to do in the remainder of this post, there is no doubt that additional income is a good thing. No matter how high your taxes get (with some very minor exceptions well hidden in the tax code) more income is always good. You never give it all to Uncle Sam. Of course, the marginal utility of that income, especially compared with the time and life energy used to obtain it, may go down very rapidly as you move into the upper tax brackets. However, the only thing worse than paying taxes is not having to pay taxes (because you didn’t make any money.) That caveat said, let’s move into the (drumroll please)
Top 16 Reasons It Sucks To Have A High Income
# 1 Progressive Income Tax System
Our income tax system is progressive. That means that the more you make, the higher percentage of your income you will have to pay. This is especially dramatic “on the margin” where your marginal tax rate takes effect. Our current top federal tax bracket is 39.6%. That means that once you’re in the bracket, you only get 60 cents of the next dollar you earn. And we haven’t even started talking about state taxes. In California, the top tax bracket is 12.3%. That means you only get to keep 48% of your next dollar. That’s quite a bit different from the 75 or even 85 cents that much of the middle class gets. (BTW-I have had the opportunity to have a 15% marginal tax rate as an attending physician. If you’d like to try it, I know a recruiter I can introduce you to.)
#2 Medicare Taxes
Social Security has its issues, but at least you don’t pay Social Security tax on your earnings once you make over $118,500 (2015.) Medicare tax, however, never goes away. In fact, it even increases thanks to Obamacare (see # 8 below.) 2.9% on every dollar you earn. Remember that California high earner? He’s down to 45 cents now.
#3 No Tax Credits
Anybody can look at a chart of the tax brackets and realize that tax day can be pretty painful for high earners. However, what most people don’t understand is that there are lots of little items in the tax code that make it even more painful than it at first appears. One of these is the phase-out of the tax credits. High earners don’t get an earned income credit, the child tax credit, the saver’s credit, the Hope Scholarship/American Opportunity Credit, the Lifetime Learning Credit, the child credit, the adoption credit, and even a good chunk of the child care credit.
#4 Loss of Exemptions
In fact, there really is no benefit to having kids for high earners. You know how everyone jokes about getting that tax break for having your kid on New Year’s Eve? You might as well tell the doc to sleep in and meet you for an induction on January 2nd. Remember those nifty little $4000 (2015) exemptions for you and each of your dependents? They’re gone completely by $380K ($432K married.) What does that mean? Well, that doc in California’s family of six will be paying an extra $13,200 in taxes.
# 5 Reduction of Itemized Deductions
But wait, it gets worse. Not only do you lose all those exemptions, you also start losing part of your itemized deductions. Remember how giving to charity or paying mortgage interest and property taxes was supposed to help you reduce your tax bill? It still does, but perhaps as low as only 20% as much as for a lower earner. This phaseout begins in 2015 at an income of $258,250 ($309,900 married.) It’s a little tricky to calculate, but the rule is that your itemized deductions are reduced by 3% of the amount by which your adjusted gross income exceeds the threshold income. So, if you had an AGI of $600,000, then you exceed the married threshold by $290,100. 3% of that is $8703. So $8703 of your itemized deductions don’t count. Sorry. Another tricky little way to raise that marginal tax rate even higher than you thought it was.
# 6 Social Security Benefits Are Progressive Too
The real deal for getting a high “investment return” on your Social Security dollars is for very low earners. The payback for every dollar taken out of their paycheck is really quite good. Not so for those who had maximal income ($118.5K for 2015) for 35 years. It’s even worse if you had maximal income for more than 35 years. Those extra years of contributions don’t do you any good at all.
# 7 Increased taxation of SS benefit
Not only do you get a much worse return on those dollars, but you get to pay more taxes on them too. High earners pay income taxes on 85% of their Social Security dollars. That’s right. You put after-tax money into this “account” and then you pay taxes again when you “take it out.” That’s like a reverse HSA/Stealth IRA. Instead of getting a break when you put money in, having it grow quickly due to the tax-protection in the account, and then getting a break when you take it out, you pay taxes before putting it in, have it “grow” slowly, and then pay taxes again upon “withdrawal.” Quite a deal, that.
# 8 Obamacare taxes
Two other poorly understood tax increases on high earners include the two Obamacare taxes. One is an increase in Medicare tax from 2.9% to 3.8% for every dollar over $200K ($250K married.) (That takes our California doc’s total marginal rate up to 56%, not counting any phaseouts, if you’re still keeping track.) The other is the increased capital gains taxes for high earners. Not only do those in the highest bracket pay 20% on their capital gains instead of 15%, but those making over $200K ($250K married) pay an extra 3.8% on those capital gains, for a total capital gains tax rate of 23.8%.
# 9 No subsidy for PPACA
Obamacare actually gets high earners coming and going. Not only do they pay more for Obamacare, but they get less. Most Americans are now having their health insurance subsidized. The Obamacare subsidies are extended to earners all the way up to 400% of the Federal Poverty Level. For a family of six, that’s as much as $128K. That includes 85% of Americans who are getting some kind of a subsidy for their health insurance.
# 10 Expected to Pay
Most doctors and others who either have or are assumed to have a high income have experienced this. When you go out with a group of friends or family, there may be an expectation that you will pay more than your fair share for the activity. Just like with taxes, that’s not all bad. The only thing worse than being expected to pay is not being able to pay, and that usually isn’t the case. But it is one reason why high-earners tend to socialize with other high earners.
# 11 Long Time and High Expense to Get There
This one particularly chafes doctors. That doc may have an income of $400K, but he didn’t start having it until 35 or 40, and at that point he was still $300K in debt. Many non-physician high earners have a similar issue. If you actually looked at their lifetime earnings, especially after-tax and after the costs of education, it wouldn’t be nearly as impressive as one might think. This is the basis for Ben Brown’s “Deceptive Income of Physicians” arguments.
# 12 No education benefit for savings bonds
Perhaps you’ve heard that you can use Series EE or Series I Savings Bonds as kind of an education savings account. If you spend the proceeds on education, they’re supposed to be tax-free. Well, not for high earners. Better pad up that 529.
# 13 Contribution Limits and Hassles
High earners don’t get to deduct traditional IRA contributions and can’t make ESA contributions. They also can’t make direct Roth IRA contributions, although at least they can now do them through the backdoor if they can figure out the pro-rata issue. But after spending literally days explaining to high earners how the backdoor Roth IRA works, there is no doubt it’s a pain in the butt that only high earners have to deal with. High-earners are far more likely to have to deal with multiple retirement accounts and even a taxable account. Lower earners can pretty much do all their savings in a 401(k) and/or a Roth IRA.
#14 Can’t Deduct Student Loan Interest
Those who most need this deduction (those with high student loans) often can’t get it. Sorry. Phases out at $65K ($130K married.) Could be worse. At least PSLF doesn’t have a phase out….yet.
#15 AMT Issues
The AMT catches lots of folks, including more and more of the middle class all the time. However, the AMT exemption phases out too the more you earn!
#16 No Need-Based Financial Aid
At least need-based college financial aid, unlike most of these issues, takes into account both income and net worth. However, having either will usually eliminate any grants or scholarships.
As mentioned at the beginning, these are first world problems. But beware, high-earners, the financial services industry isn’t the only one who sees you as a target. So does Uncle Sam.
What do you think? Are there any other ways high earners are penalized in our society? How high do you think the maximum marginal tax rate should be? Comment below!