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!
Spot on. I live in CA and the tax situation is ridiculous. I built up a side business over the past 5 years, created jobs (good, tax-paying, 200k/yr jobs) and my marginal tax rate reward for that was ~60%. This year, I shut it down. Earning 40 cents on the dollar definitely was not worth the extreme hours/effort it took to build that business.
I plan to move to WA and build a new business there.
If I were to do it all over again, I would have built my business tax-smart from the beginning: in a no/low tax state and design it to be sold for stock that I could cash out at 15-28% cap gains. I also would have started my own pension year one (that seemed overly complex, especially in the midst of getting the business going, but in retrospect it would have been a very smart idea).
p.s. the top CA marginal rate is actually 13.3%. And it’s worse than that because they calculate a bunch of stuff differently than the feds (to their gain, your loss) and they also tax your business extra once it gets over 250k. Just to maintain your LLC in CA is $820 per year.
I’d love to pay a million dollars in taxes. – said by one of the wealthiest people I have ever met personally.
The only thing worse than paying taxes is not having to pay taxes – Always true
Your priorities in life need to be re-evaluated if your decision to work less to make less has to due with amount of income taxes you have to pay for working more
Nearly every physician in America is in the top 10%, in fact most are in the top 5%. We make a lot. We also have a lot of debt so it doesn’t feel like we make a lot.
I would also love to pay a million dollars in owed taxes. Shoot, I would settle for even grossing a million. Sadly though, I don’t want to put in the time and effort that would require. My priorities are such that the amount of time required to do either are not worth it for me. I’m not concerned about paying less income tax, I owe what I owe. But I do want to know how much I am actually getting for my time, and if it’s worth my time I will work. If I don’t feel it is, I’ll do something else I like that is worth my time.
We all do this this, even in a lower tax bracket. I have some employees, that will work holidays and any extra hours, for them it’s worth it. Others will never come in on a day off because they have other things they want to spend their time on.
As far as percentages, those can be misleading. Yes, the first year making over 250K a doctor may be in the top 5% or 1% of earners. But doctors are also pretty old comparatively when they finally start their career, and they pay 400K+ to do that. Compared to my friends that started working right out of high school and made 50k a year for the past 12 years, and didn’t have any cost to start into their profession They are beating the doctor by a large sum! The doctor can keep working at his high rate long enough to catch up, but will be taxed at the top 5% or 1% rate the entire time. Makes me think twice about WCI “lifetime income tax.” It will never happen, but I wonder at what threshold would people start deciding that they have other things they want to do more than work.
And sorry about all the posts today everyone. Haven’t had anything that applied to me for a few weeks on the blog, so I have weeks up comments pent up! And it was a slow day so I had more time to write between patients.
You should spend your time (and money, since they’re often interchangeable) in the way that makes you happiest. Marginal utility is absolutely relevant.
I think the book that gave me the best insight into the money/time trade off was “Your Money or Your Life” by Dominguez and Robin.
Beau,
I feel my priorities in life are pretty square.
For me, life is a question of where best to spend my time-energy-creativity.
Building that business was personally satisfying (as a personal accomplishment) and I felt good about building substantive, high-paying jobs for my employees and doing great work for customers. But in the end, I was putting so much in and not getting enough out. And, yes, taxes figured into that. I ran up against all the stuff WCI outlined in this article (and even more CA-specific stuff he didn’t cover). If the taxes were lower, I could have afforded to hire someone else to handle some parts of the business I was running, etc.
And there were costs: to health, family time, social time, rest & relaxation, etc.
In the end, the equation just wasn’t working out.
A few final points:
The less you work, the better you can be at delivering quality. And I definitely feel freed up now to always do that “one extra thing” that increases the quality of my service multiple times per day in my day job.
Hitting the sweet spot in the tax code (for return on effort) frees up time for family, friends, charity work, personal growth, etc.
For me it’s about where best to put my life energy (as the great book “Your money or your life” puts it).
Feel free to disagree. I’m interested in your arguments.
True, I wasn’t really directing my post at you, although it seems that way. (sorry about that). I actually thought I had posted as new post rather than reply.
I do see your point though. Time vs. Money. I usually take the time. However if I had a side job that netting me an extra 100K and only took a few hours a week I wouldn’t quit it because I was only making 70% after taxes rather than 80%. Either way its a 100K with not a lot of effort. Now if the effort changes then yes…
Addendum: I couldn’t agree with you more. Its about finding that sweet spot. That is hard for me right now as I feel I am underpaid but may need to work worse hours to get better pay.
p.s.
Please write your tax book! I’ve had to learn a lot about taxes the hard way (experience + a ton of reading the tax code and experimenting in TurboTax).
I think your ability to distill taxes for people would be very helpful to a wide range of folks.
Agree!
What is considered high income? ( over $250k? 400k? 1 million? It depends?) I don’t understand my tax rate so I don’t understand what’s high based on taxes
It’s a continuum of course, but certainly by the time you’re getting toward $400K.
Thank you for this excellent post. It is timely for me, not because of tax season, but because our call auction is coming up. My income is right around $300,000, give or take. I typically transfer some of my salary to my partners to take some of my call so that I can spend more time with my family. The income reduction stings a bit, but when you look at it in terms of after tax dollars, it’s only half as bad.
#5, phase out of itemized deductions, is a new one to me. Is the threshold for it indexed to inflation?
It’s called the Pease Limitation and it is ridiculous. Everyone who makes over the threshold will pay it because it limits the deduction on the first itemized deductions. In other words you can’t escape it by deducting less. On the other hand, at least when you donate to charity you still get the full deduction because they already hit you with the penalty! (WCI feel free to correct me if I’m wrong.)
I thought charitable deductions were lumped in with all the other itemized deductions with regard to the Pease limitation. What are you thinking about? Am I missing something? I know they’ve proposed limiting charitable deductions to 28%, but I don’t think it’s ever been done has it?
You are correct, they are all lumped together, but what I was trying to say is that they disallow the first deductions, not after a certain threshold. So if you have 30K in interest, depreciation etc. and the Pease limitation disallows 10K of that you really only have a 20K deduction. If you donated another 25K to charity, you would now have a 45K deduction, so everything above the disallowed portion is fully deductible weather it’s just the 20K, or the 45K.
I guess it’s all how you look at it, sort of like Marginal or Effective tax rates. If you say “I have 50K in itemized deductions and 10K is disallowed,” you are able to deduct 80% of your deductions (marginal deduction rate.) I look at it like I can fully deduct any donation/deduction above 10K, but nothing below that (like a marginal deduction rate, 0% deductible up to 10K and 100% deductible above that, up to the next limitation…)
I see what you’re saying.
I’ve commented on your tax posts before — not understanding how your liability could be so low — but I wager this year will be more inline with what I’m paying out. I’m “interested” in seeing what my effective tax rate ends up being; I know it’s going up, but it is hard to calculate with all these variables in play.
The comment about the marginal utility is spot on. The last few months of my year are taxed in the highest bracket…you know, that same time of year that you’re working in the hospital while your family is spending the holidays without you? Kind of feels like you should be keeping more of that dollar than less of it.
your #11 really hits home. My income has only recently risen (last 3-4 years) to where it is today. It doesn’t help because end up paying a lot of it in taxes. Sometimes it makes me wonder if it has been worth it, financially at least. I am hoping time and being frugal will help me catch up.
As others mentioned, one has to determine when that marginal rate is worth ones time/energy.
Particularly when ones peak years are usually when ones kids are growing up.
Agree with the sentiment of frugality with our oppressive tax system. When factoring in my medical practice has overhead of 50%, you really see every dollar that hits your bank account would have been $4+ prior to expenses and taxes. A penny saved is 4 pennies earned!
Obviously a silly article as there is nothing wrong with earning more; zero, zilch, nada
Be happy don’t worry
I don’t think anyone said that they have a problem with earning more. I think the article is a reminder that it may be more worthwhile to take that little time off during the year because you are not actually taking home as much as you think you are. Or, it may be good to work a little more this year so you get closer to some threshold and then work a little less next year etc. Sort-of like bunching deductions.
Ummm, what?
I agree that if you’re working the same job (hours, effort, stress level) and can get paid more for it, that is absolutely worth it and whatever extra taxes you pay don’t really matter because you didn’t expend any extra effort, hours, stress.
But, if you’re working a side job, extra hours, or killing yourself to build a side business…do the tax math, it may not be worth it.
I really enjoy your posts, but this one is a bit deceptive to those who don’t read closely. Yes, at high income levels you pay up to 39.6% on every dollar earned OVER $457.6k. You said many times in the article “once your in the bracket” but I don’t think many people sit down and calculate what their net tax rate is. If you earned $458k, your net federal tax rate is only 30.19%, not 39%. Perhaps you should add a table to #1 or insert a JAVA calculator so that people can actually see how high their taxes really are. The numbers shown are from here:
http://www.dinkytown.net/java/TaxMargin.html
Everything is deceptive to those who don’t read closely. This is actually one reason doctors get burned so well, they don’t realize there are precise meanings for financial terms just like there are precise meanings for medical terms. It’s far more complicated than many calculators make it due to phaseouts. If you’re paying 39.6% in federal, 5% in state, 3.8% in payroll, and in the process of losing a phaseout, that marginal rate can be far higher than 39.6%.
And even higher for self employed doctors who have to pay their FICA and Medicare as an employer and an employee. (But I get to deduct the employer part at least, yeah!)
Exactly!
PEP/PEASE phase-outs
AMT eliminating all your usual write-offs(state taxes, property taxes, personal/spousal/child exemptions, etc).
ACA taxes
These all work together to drive marginal rates much higher than simple tables/calculators would lead you to believe.
I would argue that the way congress constructs taxes is very deceptive. The advertised marginal rates are not the true marginal rates.
I would love to see a graph/calculator which showed true marginal rate (especially if you could input your state).
My solution:
Calculate all of these phase-outs/AMT/etc and determine my personal true marginal rate graph. Identify the sweet spots (most gain for least effort) and only work that number of hours each year. Take the rest of the time off and enjoy life.
What I don’t understand:
We are supposed be a capitalist, entrepreneurial-encouraging country…but the tax code (if you understand it) clearly does not incentivize that.
Only thing I can figure out is that maybe the hours I don’t work are worked by someone else and therefore we have more full employment???
But that doesn’t account for starting a new business, in a new field that didn’t exist, seems that would grow the overall pie and not take hour/income from anyone.
That calculation is easily done with a tax software program like Turbotax. Just change your income every few thousand and plot it out.
That’s what I ended up doing, using TurboTax to make my own personal graphs.
But it gets complicated when you have so many variables: day job income, side business income, all the different tax sheltering options for each, business expenses, home office expenses, state tax weirdness, etc. A lot of interaction effects.
I wish turbo would allow you to choose 20 inputs, put them on one screen, and allow you to twiddle the knobs. Kinda like a more customizeable TaxCaster (which I love! isn’t it odd how Turbo’s best tool is free).
Plus you have to re-do your graphs each year because of tax law changes, and really you need to do it throughout the year as you’re making business decisions.
It’s doable. I did it. I just wish there were a better tool.
It’s also very difficult to figure out what the heck is causing sudden step functions in your marginal rate, and weird effects like where earning more money lowers your marginal, or earning less increases it, or not taking deductions lowers your net tax, etc.
You can use the tax bracket calculator here:
http://www.taxact.com/tax-information/tax-tools-and-calculators.asp
#10 always kills me, because I can’t explain any of this to friends and family, I would sound like a whiny tight-wad. My wife and I budget $50 for Christmas presents for family members ($100 for each other), and to our family that may make us seem cheap. But it’s because we write a check for $4000 every month to the South Carolina student loan corporation, and we don’t get to deduct any of that interest on our taxes, etc etc.
Our daughter was born January 3. After the second time someone said to me, “Ouch, you just missed out on that deduction for the previous year, sorry” and I explained that it didn’t affect our taxes because the child tax credit gets phased out, I stopped trying to explain it. The first person thought I was an idiot who just wasn’t aware there was a child tax credit. The second person clearly wasn’t interested in hearing why my taxes weren’t affected by my child’s date of birth. Now I just say, “Yeah! I wish I could have had a New Years Eve baby!”
All 16 of these points make it hard sometimes to relate to normies.
Two comments on the above.
RE the PPACA subsidies (#9) – Maybe I don’t understand your comment, but how do you calculate 85% of Americans? 85% of those with coverage on the exchange? My income currently may be below 400% of the poverty line, but I would only get a subsidy for health care if I selected health insurance through the exchange and my employer did not offer me an affordable plan that meets minimum coverage standards.
And generally, do you see these items simply as the frustrations of a high income? Or do you see them as problems that need to be addressed? Will we see a post outlining solutions to the above issues?
Whether they’re frustrations or problems is a political question, and not much point in debating that here. The 85% simply refers to the portion of Americans who would get a subsidy if they were buying on the exchange. Obviously, many don’t because their portion of the premiums are lower through their employer’s plan.
While I think it’s good to have a general idea of how taxes hurt you, focusing too much on taxes leads to bad financial decisions. Too often people don’t realize that they will have more money without the tax avoidance. Additionally I’ll say I feel it’s a privilege to pay taxes. I have a nice problem. My life events have allowed me to understand that. I still think one should be smart about taxes,just not overly focused.
I agree with this, I know many a doctor who upgraded all his equipment just because of the bonus depreciation a few years back. He would have received the same depreciation, just not all at once before the bonus, but that made him decide to get all new everything when nothing was needed. Spent a fortune to save a few bucks on taxes one year…
I think this comes down to really understanding taxes and maybe something to do psychologically with getting back something you feel was taken, idk. It makes zero sense to SPEND MORE to save a little on taxes. Those kind of deductions, auto/depreciation/etc…only makes sense if you actually need the stuff, otherwise a simple napkin calculation will show keeping a dollar is more money than only paying 80 cents/dollar for something you dont need.
Unfortunately, you hear these tax “tips” all the time. Spending a dollar to get back 20 cents is not a tip.
I agree it is a privilege to live in this country. I’ll pay every cent I owe in taxes, but I’m not leaving a tip because “it’s a privilege to pay them.”
I always tell my liberal physician friends who think taxes are too low that they can pay more in taxes anytime they want — just stop claiming any exemptions, deductions, etc. Heck — over-report your income if you want to, you won’t get penalized for that.
But none of them ever seem to want to “leave a tip” to the government, no matter how much of a “privilege” they think it is to pay taxes. Their accountants work just as hard to minimize their tax bill as mine does.
I think the most important take home from this very good post is that physicians have a tendency to think magically about their income because they don’ think about this litany thing you describe. What I mean is that if their income goes up $50K, they think they are going to have $50K more to spend, invest, pay off debt, whatever. I’ve never gone wrong by taking every dollar I earn or any tax deduction I intend to claim and cutting it in half in my head. The worst that can happen are pleasant surprises when your bank account has some nice padding at the end of the year.
I completely agree with the article. It’s very frustrating. We paid $40,000 in student loan interest and can’t deduct a dime. That’s the most frustrating item for me. That and the sign-on bonus; it came from the hospital so it was non-employee income box 7 in 1099-misc. We get to deduct 50% on taxes due as self-employer– but that goes into the deductions before AMT. The AMT added all that back on so that deduction while listed really got washed out. Thanks AMT.
The IRS really needs to look at income/outflow to determine exemptions. Why does someone who pays 2500 in interest get all of it, someone who pays 25000 interest gets 2500 (if their magi is acceptable) or maybe $0 if it isn’t.
I’m okay with taxes, and even progressive taxes to some extent. But don’t double/triple penalize. Physicians are right in that area where they don’t get the benefits for super rich (1M up advantages) but are too wealthy (read high income earners.. there is that net worth people forget about… and extra insurance issues, DI, malpractice, etc) to get the deductions of lower earners.
my wife and i get so frustrated by the inability to deduct student loan interest.
we all know how hard we work to take the best care of our patients, and how much we sacrificed in training – both in terms of time and income.
yes, i feel very fortunate to make what i make. but to take away any break that we might get just plain stinks.
as soon as our student loans are paid off, both of us are going to cut back our hours considerably. the marginal utility of a few extra dollars are not worth the additional stress and exhaustion. can’t wait to get down to 60% time!
Interesting comment. I have often thought it would be better to have a progressive tax code not based on just annual income, but on lifetime income. So a doc coming out of residency would have a relatively low tax burden for a few years while a 65 year old who has been making $75K for 45 years would have a high one.
Another interesting topic comes with the idea of burnout. Lets say you are a ED doc, hospitalist, or a physician that does hsift work. The question is:
What is better to work for 14 shifts a month for 21 years, or work 21 shifts a month for 14 years because you burned out and can’t work any more?
Because of the progressive tax code, you are actually better off working less shifts a year making less money in the higher tax bracket and therefor for the same income, will pay a ot less in taxes. This obviously does not include potential growth of this money through investments.
It does come to thinking, If I make an extra $2K putting in more work, but only get half of it because of taxes, I may choose to not take that extra shift.
Our tax system is way too complex and rediculous.
Absolutely. I wrote about that in a post about all the reasons early retirement may not be worth it.
https://www.whitecoatinvestor.com/14-reasons-why-you-shouldn%E2%80%99t-retire-early/
Or as it is with so many other things in life, there could be a middle way that may work out best for some people. One could work full time until there is no need to contribute any more money into retirement accounts and then work as locums just a few months every year (or half time every week)to take care of yearly expenses until they are 65 or can’t work or don’t want to work. This will allow them to take maximal advantage of the current system and do what they are skilled in doing for much longer.
It is a no-brainer that from almost every perspective, working longer is better than retiring early. I had the good fortune, when I first went into private practice, of having a senior partner who was very wise. He talked me through the math of why I would come out far ahead if I paced myself, made a little less, and worked an extra 10 years. Before that, I had dreamt of retiring in my mid 50’s.
No matter how much I killed myself and neglected my family, I wouldn’t have been able to accomplish a mid-50’s retirement, but even had I succeeded, it wouldn’t have been a good approach and I would have died young.
I made a decision in my first year of practice to aim toward working full-time until at least 65, and part-time until at least 75. I’m a surgeon, so I will have to adjust how I work, but I’ve seen others do it. That conscious decision has affected a lot of things — not least how I take care of my health, keep myself in good physical condition, etc.
And given progressive tax rates, we are essentially financially rewarded by the government for pacing ourselves and lengthening our working careers — and punished for trying to run sprints rather than marathons.
That is a true statement. The government punishes you for sprinting.
Well put! I wish I had read that sentence about 20 years ago.
Im not sure if this is the appropriate place, but it’d be nice to hear from some of the readers on what “effective” tax they are paying. We’ve read from WCI that his is ~15% or lower. I just did mine and I’m nowhere near that. 22.5% on ~350k (federal only).
It’s bad when compared to WCI, but as I sit back and think that paying less than a quarter of my earnings to have the privilege of living in this fine country, I’m not so upset.
2014 I was at 37% effective tax rate (fed/state combined) despite socking away 145k between my wife and myself in 401k/profit sharing/cash balance plan/HSA/529 plans etc.
Sorry, I was not clear. The 145k was the tax deductible portion of our savings. So even with 145k in reduction in tax liability, we still paid 37% in taxes 🙁
Just to clarify, I’m at 22.5% on 350k net income.
Im assuming yours is so much higher due to (1) a much higher income and (2) a greedy state
Are you including medicare, SS, federal, state, city taxes? Plus is 350 listed on your W-2 as your gross income or you are coming to this number in another way?
No, that’s purely federal. Im in FL so theres no other tax except medicare and SS. (well there are other taxes like property and sales, but all of these are deductible).
If you add the payroll tax Im at 26%
It won’t be 15% this year. Probably closer to 25%. As you mention, good problem to have.
Another upside of being screwed out of all kinds of tax breaks and incentives: filing taxes is actually kind of easy!
After reading WCI book, I felt inspired to do my own taxes this year (WCI advises to at least try it, so I did). To my utter surprise, it was actually quite easy. There really isn’t that much to do for a W2 employee on income side, and since you don’t qualify for any credits and few deductions filing was actually a snap. I did use turbotax to confirm and its all good.
but a word of warning to those who will use turbotax and don’t live in a state with income tax: it did NOT prompt me to deduct sales tax! Fortunately I read here that it could be done and knew where to add it, but it did NOT prompt me to deduct it. make sure you do if youre lucky enough to live in a state without income tax.
Just did our taxes in HR Block TaxCut and it most certainly did prompt for sales tax and had several calculators to help figure it. I’ve long ago gave up TurboTax and every year find another reason to be glad I did. I frankly don’t know what they could do to make TaxCut better. It is already pretty slick and easy.
Thanks for the heads up…maybe I’ll run our numbers thru there as well, just to see if they come up with anything I missed. This may be an fun experiment (geek alert)
I used to do that and came out with the same for Turbo Tax, Tax Cut and Tax Act. Since tax act was the cheapest I went with them. Granted I haven’t been able to do my taxes for year, well, have chosen not to. When it was a simple W2 I had no problem, but now that there are other complications and multiple filing deadlines etc. so I hire someone to do it and the accounting.
If your only income is W-2, there is little reason in my book not to do your own taxes.
To be fair you could come up with a comparable list in the other direction. For example, all the tax deductions for things like mortgage interest and HSAs are worth a lot more if you are in higher tax brackets. My wife and I do an HSA and find that the tax deduction alone comes close to paying for the entire deductible making it essentially a no deductible plan where we get to keep the savings. For someone in a lower tax bracket it doesn’t come close. I think the biggest bite is for high wage earners. Self employed or business owners with with high earnings have a lot more ways to shelter income.
But I agree that the most misunderstood aspect of a medical career is how income is condensed into much fewer productive years that start later in life.
That’s true, but on the other side all the healthcare that I provide to my employees is not just deductible, it’s never even reported on their tax return. So while they don’t get to deduct it, they also get the extra few thousand dollars every year tax free, even if it’s the 20% bracket instead of a 40% bracket.
I’ll take the deduction and the ability to make a great living, but I also went to another 12 years of school to be able to do that. Whereas most of my employees got into the field right out of high school and either learned on the job or did a 9 month program.
Absolutely. Of course, you could also argue that the standard deduction is a giveaway to the poor/lower middle class, since if they had to itemize they’d never get to $12K.
Kent,
That seems like a fair point on mortgage interest deduction, that is the one deduction the AMT does not eliminate…but then the PEP/PEASE comes along and takes it away anyway.
HSA may be the one and only counter-example. All of the other deductions/exemptions that would appear to have much more value to high-earners are eliminated at those income levels.
A stronger argument might be asking why muni-bond interest is tax free.
Although you could counter that with:
Serves the greater good by funding state/city infrastructure at lower rates.
Anyone can buy a muni bond (welfare to billionaires).
Careful on HSAs. The only deductible amount is over the 10% threshold, and you can’t deduct dollars you spend out of HSAs. We didn’t spend enough in medical bills to be over the 10%, so we could NOT deduct the premiums for the plans. The HSA money doesn’t count and the premiums didn’t go over the 10%, erego, even though we have HSA (which is still cheaper dollar for dollar than a non-HSA plan) we can’t deduct that. Low income earners have a smaller 10% (ok 7.5% if you are old enough) threshold, so the HSA premiums are probably deductible for them more easily than for higher income.
Sorry, I disagree. HSA hurts high income earners too
I’m not quite sure what you’re talking about here. The 10% refers to Schedule A Medical Expense deductions (a below the line deduction). That is totally separate from self-employed premium deduction (above the line) and the HSA deduction (also above the line.)
I started an MBA this year and my first class is Microeconomics. There are some interesting terms that I never hear discussed in the political debates regarding taxes (or maybe now I am just more tuned in).
The first concept is deadweight loss, which is essentially economic transactions that don’t occur because the tax impact on the demand curve. More people are willing to buy a car for $10,000 (example) than $10,000 plus a $1,000 (10%) sales tax. So, we only see X cars at $11,000 instead of X1 (a higher value) of cars at $10,000. So, fewer worker hours at the factory, fewer sales jobs, etc.
The second is tax incidence. In economic terms, taxes are paid by both the seller and buyer, regardless of the legal entity to whom the tax is assigned. Politicians may argue that the “Cadillac” tax is levied only on insurance companies, but consumers pay it too in the form of less benefits. On the income tax side, society is paying for higher income taxes in the form of fewer services or goods purchased by the high income worker. Especially if the high tax ends up changing the high earner’s behavior (she works fewer than the optimal # shifts because the marginal income isn’t worth as much.)
Gotta watch those unexpected consequences! Hard to say which is worse for society, less economic output to be taxed or lower amount of public money to spend on stuff private individuals won’t buy due to the tragedy of the commons.
Well this definitely took some air out of my balloon. At least it lets me know that I didn’t do my taxes totally wrong this year…I have been shocked by how much my “refund” has swung the other direction going from low-earner to high in one year. I’ve been scared to believe it.
interesting comment. in my first year making $ as attending we got a HUGE refund since they were withholding based on my income for a whole year but in reality I only made $ for 6 months
So what is the effective tax rate for charity for persons earning around 500K?
I’m not sure I understand the question, but it would depend on how much charitable donations you have. In the example above for the 600K earner, if his entire itemized deduction was $8703, then the entire thing would be disallowed, making it a equal to your marginal tax rate. If he was like WCI and had about 60K in charitable giving and his total itemized deduction was 60K, then he could deduct $60,000-$8703=$51,297. How much that deduction was worth depends on your federal rate(about 40%), state rate (variable state to state) local tax etc. But if your federal and state tax is about 45% at 600K, then the deduction would be worth $23,083 in tax savings, or about $4,000 less than without the “Pease tax.” (But remember you had to spend the 60K to get the 23K back in the first place.)
Granted, this is very simplified and doesn’t take into account any other itemized deduction or weather the first case should even itemize etc. but hopefully I didn’t get to confusing. It’s easier to explain in person than write down, sorry.
I forgot to mention that I believe they can only take away up to 80% of your deduction, so there would still be some allowed in the first example.
thanks for the nice reply. Wish there was a like/thankyou button on the comments.
Another downside to having a high income is the inability to protect a greater percentage of it with comprehensive individual coverage. For example, someone earning $1.3 to $1.5 million a year can only protect $30,000 a month of it. That means only about 25% of their income is covered. Contrast that with the 60% of coverage someone earning $100,000 a year is eligible for.
First world problem, but being married and filing jointly to a higher income spouse means that my puny salary gets clobbered by the higher tax rate. I believe this is what they call the marriage penalty? But the tax hit was worth my nice hubby. 🙂
My favorite comment! (Hopefully my wife feels the same!)
Every now and then she want’s to go out and “help,” but every time we go over what she would actually make if she did that she thinks twice. What she does for our family is worth way more than any hourly job she could do, especially after half disappears in taxes.
I have friends who are a physician couple. I calculated their marriage penalty to be worth about $30K a year. Over a 25 year marriage and career that is work well over a million dollars if invested properly. Makes you think twice about getting married.
I had someone emailing today actually considering just having a family ceremony without a formal marriage for just that reason.
If you are religious, there is no reason why one can’t have a wedding ceremony that is religiously valid but not registered with the state — just as one can have a civil marriage that is not ecclesiastically recognized for a given religion.
Even the non-religious can have a “family wedding” or some-such.
The only hitch is this: if you live together and especially if you represent yourselves as married and, say buy a house or pay rent together, eventually you will have a common law marriage.
I am not aware of whether the IRS goes after people who are in common-law marriages if doing so will make them pay more in taxes, but after 3 IRS audits and 3 state audits (came out great on all of them), I am convinced that there is absolutely nothing that the IRS will not stoop to, especially in going after middle to upper-middle class earners.
My wife, trained as a teacher, loves being able to volunteer at the school on her terms, but not have to show up when she doesn’t want to. She doesn’t work for money because it would be literally well under minimum wage.
https://www.whitecoatinvestor.com/the-hidden-costs-of-a-dual-income-household/
I see the theoretical reason for given tax benefits to married people but that benefit runs out when you bump a tax bracket or two. And personally I never met someone who got married to get a higher deduction. Personally I’ve always thought taxes should be independent of relationship status.
My wife went back to work, primarly because she loves being a nurse, but also for the health insurance and as I am an independent contractor and covering our family of 5 was not an insignificant cost. She works part time (2d/week), and does her best to get called off whenever their is overstaffing purely for the reasons already stated.
We have tried to minimize the marriage penalty hit but converting almost her entire salary into pretax vehicles. Health/Vision/Dental, FSA for healthcare, FSA for child care, life insurance through employer, DI through employer, 401k, etc.
She finds it annoying that she never gets a “paycheck”, but we ultimately find it to be awesome as she gets to do something she loves and gets to keep “all” her money.
That’s a great way to do it! It’s probably the only way it would make sense for my wife to go back to work from a financial perspective.
My wife is also a nurse, and I am an independent contractor as well. We ended up running multiple scenarios and the best combination of time/money was for her to quit. We had no awesome health plan or benefits at her jobs to have to consider, making it easier.
It turned out she would have to more than double her income to make up for the savings of staying at home. Due to my income she’d be taxed at the marginal rate, and time away from kids, cost of daycare, etc…..didnt add up. Now, add in the fact that since you’re self employed you can set up a SEP-IRA in her name and then deduct another 52K from your income and its a no brainer. Being paid to stay at home, its awesome. Now on 300k we can sock away 104k/year and halve our tax commitment and secure our future. Not quite there yet, but getting there.
There is no such thing as a spousal SEP-IRA. She has to actually have some earned income to use that. Are you paying her to do something?
Probably right about the SEP part, as thats just my own situation. Maybe they would limit her to regular IRA contribution limits. Though a sep is technically a traditional ira, since she isnt the self employed one it makes sense…too good to be true. I’ll still plan on maxing out a typical spousal IRA while I iron out the specifics. Most sites and even the IRS are rather vague. It does say her contribution cannot be greater than mine or than our earned income, but probably goes without saying they didnt mean a truly maxed out account. At any rate I’ll get it clarified and report back.
Of course can only do the standard 5500, but thats better than nothing for sure.
This is a very timely post with tax season coming. This is the first year we are making more on DH salary as an MD, compared to pharmacist + residency (quit 5 years ago when moved for DH’s job). All these tax scenarios and hidden costs of 2 incomes is new to me because I got a job part time in 2014 and we’ve never made this much. Not yet a ‘high’ earner but if I keep picking up extra shifts/full time, we could hit $250K. Child care costs eat lots of my salary, but now I’ll have to do tax scenario’s too. It’s nice to read how others handle their wives work (I also love to work like Tex’s wife- good advice about turning shifts down) Thank you WCI for an interesting post.
Well, I’ve been both highly and minimally taxed (low enough to get Earn Income Credit, in fact). I’ll pick the former any day of the week!
I agree. My 25% effective tax rate sure beats 5% effective + deployments.