Saturday, December 01, 2007

More Than 40% Pay Zero Federal Income Tax

If you're reading this article, I am guessing you are probably in the 60% that do pay federal income taxes. Of note, most of the non-payers are not wealthy people using tax loopholes. The majority are lower income taxpayers who are single and use the Single or Head of Household (i.e. single with a dependent child) filing statuses. Also, some of the non-payers get a refund that is actually greater than the amount of their federal withholding, due to Earned Income Tax Credit (EITC) which is an anti-poverty tool that is implemented through the Tax Code.

When I first heard this statistic, I was surprised at the magnitude of the percentage. However, one only needs to check a few sources such as the Tax Foundation or the Heartland Institute to confirm the numbers. It is worth noting that these people still pay taxes, even if they don't pay federal income tax. Non-payers of federal income tax still contribute to payroll taxes (social security and medicare), sales tax, and excise taxes.

While I realized that the majority of federal income taxes was paid by a minority of taxpayers (e.g in 2004 10% of taxpayers paid 68.2% of the federal income tax), I didn't realize that such a large proportion (i.e. over 40%) paid no federal income taxes at all. Somehow, that doesn't feel right. I don't believe a tax system that allows 40% to opt out is sustainable, especially if that segment requires signficant services from the government. To me, this would similar to 40% of a company doing no work and the other 60% carrying the load so that the company can make money. I don't believe such a disparity in contribution can work for very long.

With the upcoming Presidential elections, I will be very interested in how federal income tax code issues are addressed. Based on my limited exposure to the candidates so far, I expect I won't be very impressed with any of the proposals. It would be great if I were pleasantly surprised in the next few months :-)

For more on Reflections and Musings, check back every Saturday for a new segment.

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This is not financial or tax advice. Please consult a professional advisor.

Copyright © 2007 Achievement Catalyst, LLC


minimum wage said...

I earn minimum wage and I pay federal income tax. I'm definitely not in the 40th income percentile, so what am I doing wrong?

Adventures In Money Making said...

while i expect my income to drop significantly next year, in 2007 both my wife I worked.

We'll be sheltering our income through real estate phantom losses (you can deduct upto $25k per year against regular income), 401k contributions, splitting income into separate entities like Corporations and taking advantage of tax deductions you from investing in certain asset-classes (like oil drilling).

Anonymous said...

Also, the number of kids you have plays a huge part in eliminating your Fed Income Tax bill. I am one of the people in the 40% numbers you mention above and I make $75K/year. I've gotten to a point, with the number of kids I have for deductions, that limit my taxable income. Because of that, my tax liability is low enough that all the Child Tax credits wipe out any tax bill that I would have had. I bet you would have to be pretty poor to not pay Fed Income Tax if you didn't have kids. It also helps that I put so much away Pre Tax for retirement and I give away so much money that my Taxable income is only $28K/year. Basically, a quick way to not pay Fed Income Tax is to qualify for some of the Tax Credits. Deductions are good but they don't come close to saving you money like the credits do.

minimum wage said...

If you have money, not only can you make even more money by buying real estate and renting it to rent slaves who cannot buy a home, you also get to reduce your taxes by taking a paper loss for depreciation while your real estate asset is actually appreciating.

Is this a great country or what?

Super Saver said...

@ Minimum Wage,

Thanks for your comment.

As Anonymous and Adventures in Money Making noted, tax credits, adjustments and deductions are the elements that enable filers to have zero federal income tax liability. The standard deduction is available to most people and the Child Tax Credit and Earned Income Credit are credits that help many lower income households achieve zero tax liability.

If you have children and are not using the mentioned tax credits, it would may be worth checking with a tax advisor on whether they apply to your situation.

@ Adventures in Money Making,

Thanks for the info on Real Estate deductions.

I think Real Estate is still a good tax deferral investment, although the tax code has reduced tax benefits from the time I invested in a warehouse (about 20 years ago).

@ Anonymous,

Thanks for sharing your experience with federal income tax liability. I think it is great you are able to achieve zero federal income taxes at your income level.

Excellent point on credits being the main way to get to zero federal tax liability. At $1000 per child, the Child Tax Credit can reduce taxes owed significantly. Also, congratulations on saving for retirement and giving to charities.

Also, if you aren't aware, The Additional Child Tax Credit may help capture any unused Child Tax Credits, because of already being at zero federal tax liability.