Let me give an illustration. Pretend for a moment that I make $100,000 at my job. This sometimes is called gross income but really is just my salary and bonus. Because of other adjustments (stock trading, real estate depreciation, etc.) I only have $90,000 of Adjusted Gross Income. This is important to remember because it is one of the numbers that is used when reporting income statistics from the federal government.
For the IRS every year, my job is to lower that $90,000 as much as legally allowed (I definitely advocate following the law, more on that later) and only pay the minimum amount of taxes I owe. I always laugh at people who complain that they are not paying enough in taxes (Warren Buffet, George Soros, Bill & Hillary Clinton, etc.). They can always not take all of the deductions and exemptions they are allowed and thereby pay more in taxes. In fact I will make them an offer. Pay me $100, I'll fill out your tax return and guarantee that you pay more in taxes. The IRS doesn't fine you if you pay too much. They only care if you pay too little.
Anyway, we'll start with assuming that I pay $8000 in morgage interest and $7000 in state and local taxes. That reduces my taxable income to $65,000. Next, I was generous and gave $10,000 to charity. Now I am at $55,000. Finally, assume I have a family of 6 (2 adults and 4 kids). This gives me $21,000 in exemptions and I now have a Taxable Income of $34,000.
Let's recap that again:
$100,000 salary
$90,000 Adjusted Gross Income
$34,000 Taxable Income
In other words, by availing myself of only the most common deductions, the USA says I only need to pay income taxes on 34% of my income. Roughly based on the current tax brackets I owe $4000 in income taxes. Not bad, only 4% of my income. Of course I paid an additional 6.35% in SS taxes and my employer matched that so I pay three times as much SS taxes as I do income taxes, right?
Wrong. $4000 is the tax liability to me. The government already took out $8000 from my paycheck so I should be getting a $4000 refund? Wrong still. We still have our credits. Since I have 4 kids that is $1000 per child. (Interestingly, each child was worth about $4000 as an exemption which in the 25% tax bracket would be the equivalent of decreasing tax liability by $1000. Doesn't that sound like double dipping to you? Well, it is and the government allows it and unless your filling out your tax return by hand, there is no way you can not get this benefit. All the tax software does it for you.)
So already, my tax credits meet by tax liability. But wait there is more. Remember the 2008 economic stimulus. Well, technically that is a tax credit for this year's taxes. However, assume my wife gave birth to a child last year. That would mean they are giving us another $300 tax credit because they didn't give it to us last year. So now, besides getting back all the income tax that was withheld, we are getting back an additional $300. So even if the government had withheld no money from my paychecks, I would still be getting a refund. And that is just with two tax credits. Imagine what my situation would be like if I qualified for more.
In spite of not paying any income taxes, I don't feel guilty. Here is why. I pay state and local taxes, I pay sales taxes, I buy from corporations who pay corporate taxes. Moreover, I pay SS & Medicare taxes. While these may be earmarked for the SS trust fund, the government (by law) borrows from this fund to support all of the spending that they do. With the way the system is structured, I believe there is no chance I will see any of that money when I retire. Also, I buy US Savings Bonds thereby keeping some of our national debt out of foreign hands. (In other words, I don't owe the government anything, they owe me whenever I cash in those bonds, thereby getting back more of my hard earned tax dollars). So, the moral of the story is that if you want to lower your taxes, get married and have lots of kids.
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