Wes Moss: Think you know your tax rate? Think again

Certified financial planner Wes Moss provides personal finance advice and accessible investment strategies. His guest post appears here weekly.

Wes Moss hosts 'Money Matters' Sunday mornings on AM750 and 95.5FM News/Talk WSB.

Wes Moss hosts 'Money Matters' Sunday mornings on AM750 and 95.5FM News/Talk WSB.

Do you know how much you really pay in taxes? I’m talking about all your taxes: income, capital gains, property and sales taxes. Most people I ask tell me they pay about 30 percent. That may sound high, but it turns out to be right. And part of it has to do with living in Georgia.

When I gauge a client’s approximate overall effective tax rate, I often go to moneychimp.com. Check it out. You may be surprised to see how low your “effective” federal tax rate is.

But it’s probably not your actual tax rate. Most tax calculators don’t show all the areas that take a hefty chunk out of your paycheck. FICA and state income taxes are two of the big eaters at the paycheck buffet. Here’s what I mean:

Let’s say the Joneses earn $110,000 a year. Although their overall effective rate is only about 18 percent, the moneychimp tax calculator more accurately indicates their tax bracket is 25 percent. That’s because our tax system is progressive; you pay a higher percentage on your earnings as they go up and pass certain thresholds.

So 18 percent now seems like a pretty good deal. And, for most of you lucky retirees, 18 percent is pretty representative of what you pay overall. But for us working folks, 18 percent is just the tip of the iceberg.

Enter FICA, the 1935 Federal Insurance Contributions Act that established the tax-funded funding Social Security program. For 2013, the FICA tax is 6.2 percent on the first $113,700 you earn as an individual. So for the Joneses, making $110,000 and in the 25 percent bracket, we have to factor in an additional 6.2 percent tax burden. And, we pay another 1.45 percent tax on everything we earn for Medicare.

Let’s do the math

We started at 18 percent, then added 6.2 percent for FICA and then added another 1.45 percent to reach a grand total of 25.65 percent. That means 25.65 cents of every dollar the Joneses earn go toward taxes.

I love living in Georgia — as I’m sure the Joneses do, too — but it’s not a cheap state. Georgians pay 6 percent income tax. (Georgians older than 62 likely pay less, as some state income tax exemptions begin to phase in).

OK, back to our calculators. Let’s add that 6 percent to the 25.65 percent we came up with earlier. We’re now at more than 31 percent.

That means nearly one third of every dollar you earn goes toward taxes.

Taxes are inevitable. But there is a simple methodology to keep you sane and on the path to retirement freedom. Come back next Monday and we’ll discuss that.

Editor’s note: A quick word of congrats to Wes, who’s been named by Wealth Management magazine as one of the country’s top 40 wealth managers under the age of 40.

Follow Wes Moss: Twitter | Facebook | Email

– Wes Moss, for AJC Atlanta Bargain Hunter blog

6 comments Add your comment

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Charles Ellis

January 21st, 2013
10:13 am

Interesting information…. but as far as taxation, it’s jut the tip of the iceberg. Gas tax, sales tax, real estate property tax, auto tag tax (which is being phased out in Georgia in to a one time fee) plus many other obscure taxes and fees that add up. Many people in the above example by Mr. Moss may in fact pay 50% or more of their gross income to federal, state and local taxes.

All the more reason to maximize all pretax contributions that are allowable by the tax code: traditional IRA’s and medical savings accounts as well as 529 funds if you have children.

Solid financial planning advice when started in your early 20’s (and sticking with it) is worth it’s weight in gold.

Eugene Patrick Devany

January 21st, 2013
11:10 am

“[T]he increasing differences between those few who grow ever richer and the many who grow hopelessly poorer, should be a cause for dismay,” according to Pope Benedict XVI in his address to the Diplomatic Corps on January 7, 2013. The $1.3 trillion in U.S. tax expenditures illustrate the problem. Between 1995 and 2010 the top 10% increased their wealth by 10%, the next 40% (the middle class) lost 8% and the lower 50% lost 70% of their net wealth.

It is reasonable to ask how our so-called “progressive” tax code creates so much poverty and hinders economic recovery. In 2010 total individual income in the U.S. was $12.5 trillion. The federal individual income tax produced $898 billion and the combined 15.3% payroll tax generated another $865 billion (Social Security and Medicare). This $1.7 trillion in combined tax revenue from the individual tax base was 14.1% of total income and that is the true average tax rate. Typical wage earners below the $110,000 payroll tax limit pay the 15.3% payroll tax plus about 10% more in income tax for a combined rate of around 25%. It follows that if workers are paying way above the 14.1% average, then the high earners must be paying a true rate much less than 14.1%.

Few appreciate that the $1.3 trillion in annual tax expenditures is greater than the amount collected by the income tax (and exceed twice the total net wealth of the lower 50% of the population). Most of the approximately 250 tax expenditures are business tax incentives which offset the high marginal rates of the majority of individual business owners.

Neither the U.S. Treasury nor the IRS publishes data on who benefits from the tax expenditures by income and wealth. It is sufficient to know that the true tax rate for high earners and the wealthy is far below the true tax rate of average American workers. Because an elimination of only 15% or 20% of the tax expenditures would cause the affected high earners to pay two or three times their current tax amount, real tax reform cannot be achieved with the simple logic of cutting the tax expenditures to lower the rates.

A “revenue neutral” 2% net wealth tax (excluding $15,000 cash and retirement funds) could replace the job killing payroll taxes and enable the income tax rate to be reduced to 8% for all (because no tax break for anyone can be justified at an 8% rate). Progressive tax liability is achieved with rich and poor paying the exact same rates because half the country only has 1% of the wealth while the top 10% have 75% of the $53 trillion (2010 FY) in individual net wealth.

A 4% VAT on all business sales would also enable the corporate rate to be reduced to 8%. The U.S. would have the most competitive rates in the world and trillions in foreign corporate profits would be returned for investment in the U.S. Read more at TaxNetWealth.com.

Tea Party Patriot

January 21st, 2013
11:50 am

We need to eliminate all taxes and privatize everything–schools, roads, emergency services, parks–so people stop mooching off of me. Unlike everyone else, I EARN my money. Why should I pay for some parasite’s street to be paved? DO IT YOURSELF!!!

Lee

January 21st, 2013
10:18 pm

@Charles Ellis is right, 30% is just the beginning. In addition to all the other taxes Charles mentioned, those taxes that the “evil corporations” pay? Yep, most get passed right along to Mr and Mrs Consumer.

Look at your phone bill. Federal Universal Service Charge, Regulatory Cost Recovery Charge, Emergency 911 charge. Cable bill has a FCC fee.

It just goes on and on. I’ve read estimates that the total tax burden is over 70%. When you consider all the “flow down” taxes that get passed along in higher prices we pay for everything, sounds about right.

And still the government wants more and more and more.

DevilDogOz

January 22nd, 2013
3:43 am

Excellent article; and should be required reading to get online at AJC.com; you have a half dozen comments here on what is basic economics and will have hundreds of comments on Bookman – which shows that the masses aren’t interested in the facts, just the hysteria and hyperbole.