Feel like you’re paying too much for taxes? You are not alone.
“No new taxes!”. Those were the words of George Bush Sr. when he was running for president in 1988. Similar messages are communicated and thought of not only during election years, but this sentiment resonates in the minds of most who are trying to find ways to lower the amount of taxes they pay regardless if it’s an election year.
If I were to ask you if you think taxes are higher than they were 30 years ago, most of you would say yes. While this is true, it’s not quite that simple, let me explain. Approximately 30 years ago, there were only 2 income tax brackets, 15% and 28%. If you filed your taxes as married filing jointly, any income you earned under $29,750 was taxed at 15% and any income you earned over that amount was taxed at 28%. For single tax payers, it was 15% for any income earned under $17,850 and 28% for any income over $17,850. Today, things look a little different. If you file your taxes as married filing jointly, you can make up to $231,450 before you go above the 28% tax bracket. If you file as single, you can make up to $190,150 and still be in the 28% tax bracket. For higher income earners, the highest tax bracket for 2016 is 39.6% and this percentage is used to calculate the amount of taxes you pay for any income over $415,050 for single filers and $466,950 for married joint filers. One common misconception is that if you make $500,000, the entire $500,000 will be taxed at the higher tax bracket. While this might be how it feels, this isn’t the case. You see, your income is taxed at graded increasing levels the higher your total income is. There are currently 7 income tax brackets ranging from 10% – 39.6%. To understand how you’re taxed we need to be familiar with a few terms. You may have heard of the terms marginal tax rate and effective tax rate. The marginal tax rate is the highest tax bracket someone is in based on their total amount of annual income. The effective tax rate is actual tax rate you pay when you figure all of your income because your income is taxed at the different tax rates so some of your income would be taxed at 10%, some at 15%, some at 25%, some at 28% and so on, depending on how much you earn.
To understand why taxes go up and go down, we need to have a good understanding of where our current tax rates are in relation to historical tax rates and the amount of debt we have as a country. Historically, tax rates have followed the trend of the amount of debt we have as a country. As debt increases, taxes are raised to help reduce the debt, as debt goes down, taxes can be lowered. Since 1942 to the present year, if your taxable income was $250,000, your effective tax rate would have ranged anywhere from 27% to just under 50%. Remember, the effective tax rate is the actual percentage of taxes you pay in relation to your income. This includes years when the highest tax bracket was 91%. That’s right, 91 percent! Over the last 25 years, using the same income amount of $250,000, your effective federal income tax rate would range somewhere between 26% and 29.6%. This means that the total percentage of taxes you paid would be no higher than 30%. Now remember, just like any business or household, when the national debt amount goes up, there’s only 3 ways debt can be reduced, an increase of income, a reduction of spending, or a combination of both. Over the last 25 years our country’s debt has gone up from just over 3 trillion dollars in 1990 to over 19 trillion dollars today. All of this while the highest marginal tax rates have stayed relatively the same. Knowing what we know about the usual correlation of debt and taxes, it would be reasonable to assume that taxes will be going up in the future to help pay down the large national debt.
All of this is important because every physician we work with, taxes are a major concern, and rightfully so. It’s important to implement various strategies for reducing your taxable income not only during the present years but also we need to be mindful of what your tax situation might be in the future and positioning yourself so that as taxes rise, you have ways to reduce your tax liability. There are many strategies and ways that you can do this. Just like with anything else, the more planning that’s done, the bigger the savings you could reap. Deploying these strategies potentially equates to you having additional hundreds of thousands of dollars in your pocket and the increased ability and confidence to live the life you desire. We help empower physicians to be well prepared for increased taxes both now and in the future. For additional information on how we might be able to help you, feel free to visit our website and we look forward to helping you simplify your life!