The tax code is complicated. It’s begging for an overhaul, and I would love to know how you would change the tax code. My preference would be to simplify, simplify, simplify. But that is easier said than done when there are so many competing interests with deep pockets.
Why is the US Tax Code So Complicated?
The current tax system is progressive tax system that increases as your income increases. This article about Marginal Tax Rates and Federal Income Tax Brackets explains this in more detail. Basically, your tax rate increases as your income increases. However, only the amount of income you earn within each tax bracket is taxed at that rate, not the entire amount (as is commonly assumed).
Let’s look at the 2017 Federal Tax Brackets to see this in action.
|Marginal Income Tax Brackets||Single||Married Filing Jointly||Head of Household|
|10% Tax Bracket||$0 – $9,325||$0 – $18,650||$0 – $13,350|
|15% Tax Bracket||$9,325 – $37,950||$18,650 – $75,900||$13,500 – $50,800|
|25% Tax Bracket||$37,950 – $91,900||$75,900 – $153,100||$50,800 – $131,200|
|28% Tax Bracket||$91,900 – $191,650||$153,100 – $233,350||$131,200 – $212,500|
|33% Tax Bracket||$191,650 – $416,700||$233,350 – $416,700||$212,500 – $416,700|
|35% Tax Bracket||$416,700 – $418,400||$416,700 – $470,700||$416,700 – $444,500|
|39.6% Tax Bracket||$414,401 +||$470,701 +||$470,701 +|
Your taxes are blended at each of these rates, so you will need to do a little math to understand your Effective Tax Rate, or the amount of taxes you pay overall.
Of course, the marginal tax brackets don’t take into account tax credits or deductions, which lower your effective tax rate.
The Impact of Tax Credits and Tax Deductions
Tax credits and deductions can dramatically change the amount of taxes you pay. In some cases, you can end up paying no federal income tax at all (more on this in a moment).
Tax Credits vs. Tax Deductions: According to the IRS, “Tax credits provide a dollar-for dollar reduction of your income tax liability. This means that a $1,000 tax credit saves you $1,000 in taxes. On the other hand, tax deductions lower your taxable income and they are equal to the percentage of your marginal tax bracket. (source)”
Both credits and deductions reduce the amount of taxes you pay.
- Tax Credit – Common tax credits include the Earned Income Tax Credit, Child and Dependent Care Credit, Adoption Credit, Lifetime Learning Credit, certain home improvement tax credits, and more.
- Tax Deduction – Common itemized tax deductions include deducting the amount paid for state and local taxes, charitable gifts, the home office deduction, mortgage interest deductions, medical and dental expenses, and more.
Tips to reduce your taxes: Almost anyone can take actions to reduce their taxes, including harvesting losses by selling some mutual funds at a loss, increasing retirement fund contributions, increasing charitable contributions, and a few other things.
Half of US Households Pay No Federal Income Taxes
OK, almost half. The number is actually estimated at 47% (according to Tax Policy Center), but that is close enough in my book.
How can taxpayers avoid owing federal income tax? The main ways are having a low enough income to be exempt from federal income taxes, or qualifying for enough tax credits, deductions, and exemptions.
Not only do some people not pay federal income taxes, but due to the number of credits and exemptions, some people actually receive a tax rebate from the government.
40% of People Profit from Federal Taxes
As if not paying federal income tax weren’t enough, many people actually make a profit from filing their taxes each year.
“The bottom 40 percent, on average, make a profit from the federal income tax, meaning they get more money in tax credits than they would otherwise owe in taxes. For those people, the government sends them a payment. – Yahoo News.”
Take this example (same source):
The (recent tax code) changes made it relatively easy for families of four making $50,000 to eliminate their income tax liability.
Here’s how they did it, according to Deloitte Tax:
The family was entitled to a standard deduction of $11,400 and four personal exemptions of $3,650 apiece, leaving a taxable income of $24,000. The federal income tax on $24,000 is $2,769.
With two children younger than 17, the family qualified for two $1,000 child tax credits. Its Making Work Pay credit was $800 because the parents were married filing jointly.
The $2,800 in credits exceeds the $2,769 in taxes, so the family makes a $31 profit from the federal income tax. That ought to take the sting out of April 15.
Must be nice to get paid. 🙂
Taxes Are a Year Round Task for Small Business Owners!
I am a small business owner, which adds another layer of complexity to my situation. Gone are the days I can fire up a copy of H&R Block at Home and finish my taxes in an hour.
It’s not unusual for me to receive income from over 50 different sources. Expenses are another story entirely! I use a company called Gusto to run my payroll. I pay estimated taxes and self employment taxes on my business income. These help me avoid being subjected to underpayment penalties.
Once upon a time it was easy to track everything manually, but I now use QuickBooks Online to manage my business income and expenses. And I hired an accountant as well. The combination of these two makes taxes much easier than before. But it still requires work throughout the year to maintain.
Related: Here is a full rundown of how we manage our business finances for those who are interested in a behind the scenes look.
Taxes Are Too Complicated!
I don’t hate paying taxes. I realize that society would be very different without public money. So I am all about paying my fair share of taxes.
But I hate the act of filling out the tax forms, looking for deductions, learning the new tax rules, sifting through data, visiting the IRS webpage, and trying to determine which write-offs and deductions are allowed or not, etc. (thank goodness for free tax software like TurboTax or H&R Block!). While I honestly don’t mind paying my share of taxes, I also don’t want to pay more than I legally have to. So I double check and triple check everything to see if there is anything I missed.
Different Tax Systems & Alternatives to the US Tax Code
Each country has its unique spin on taxes. Some are very complicated, like ours. And other tax systems are very basic. Many have a combination of income tax and a national sales tax or Value Added Tax (VAT) System, in which taxes are incrementally added throughout the sales and supply chain and passed on to the consumers. In effect, this becomes a consumption tax, and is intended to pass on more taxes to those who spend more. There are pros and cons to these systems.
Different Types of Tax Systems:
- Consumption Tax
- Fair Tax / Flat Tax
- Progressive, or Marginal Tax System
- Sales Tax
- Value Added Tax (VAT)
What Are Your Thoughts on Doing Taxes?
I’ll share my thoughts on the tax system: I Hate Doing Taxes. I don’t mind paying taxes because I know they are necessary for society. My biggest complaint with the tax system isn’t having to pay, rather it is the complexity of the tax system and having to go through the filing process. There are thousands of laws, rules, loopholes, exceptions, and other rules that clutter the books and over-complicate what could be a relatively straight forward process. It is because of this complexity (and my small business situation) that I hired an accountant to do my taxes.
How Would You Change the Tax Code?
I think the tax code can be over-complicated and tricky. But changing the complexity of the tax system is not a job I am capable of doing, and eliminating the loopholes and vast number of rules would probably put hundreds of thousands of people out of work.
photo credit: woodsy.