Taxes are a complicated subject. I can confidently say many individuals do not understand how their taxes work, other than many are feeling good when they receive a refund and bad when they owe.
Like many other areas today, there are narratives that are commonly believed about taxes that are largely untrue. Today we will review 5 narratives that are often repeated, but don't have much supporting evidence.
Who is rich? And what is fair? Those are both fairly subjective terms that would need to be clearly defined to evaluate this. I'll try anyway.
Let’s say that if you’re in the top 1% of earners that you are indeed rich (from an income standpoint at least, you may still be scraping by keeping up with the Joneses but that’s a different issue).
According to www.taxfoundation.org, the most recently available IRS tax statistics come from 2021. The top 1% that year earned 26.3% of all adjusted gross income in this country during 2021, which is incredible. 1% of the people earned ~1/4th of all the income.
Did that group of people pay an appropriate share of taxes as well? It appears so. While the top 1% earned 26.3% of all income, they paid 45.8% of all income taxes. To make it into the top 1% you needed a household income exceeding $682,577.
Let’s go beyond that and say that anyone in the top 10% of earners is rich. To be in the top 10% you needed a household income of $169,800. The top 10% of earners accounted for 52.6% of all income in 2021 and paid 75.8% of all income taxes.
Were the bottom earners taxed unfairly? The bottom 50% of households had incomes below $46,637, and they accounted for only 10.4% of all earned income during 2021 and they paid 2.3% of all income taxes.
The US Tax System is one of the most progressive tax systems in the world, and it does appear to be going as intended. Higher earners pay a higher percentage of the earnings in taxes.
While Warren Buffett likes to say his secretary pays more taxes than he does, that is very much untrue as we will explore in narrative #2.
A corporation cannot pay taxes, as a corporation is merely a collection of individuals. A corporation is a legal entity, a piece of paper.
Humans pay taxes, not pieces of paper. Your home does not pay your real estate taxes, you do. A corporation is made up of employees, shareholders, and customers. That's who pays corporate taxes.
Corporate taxes are paid for in one (or all) of the three following ways:
• Lower wages for employees
• Lower investment returns for shareholders
• Higher cost of products or services
So, if you are an employee, shareholder, or customer of a business (which I’m sure encompasses everyone) then proposing more taxes on that business is simply proposing more taxes on yourself.
Mr. Buffett owns over 30% of Berkshire Hathaway, which paid over $23 billion of taxes in 2023. While he was not taxed directly on his individual return, an entity he owns paid substantial amounts. His shares of Berkshire stock would likely have a much greater market value had those taxes not been paid.
We do quite a few Roth IRA conversions for clients every year at Meredith Wealth, but unfortunately there is not a rule of thumb to determine the value of this strategy for everyone.
It is definitely a subject that should only be evaluated on a case-by-case basis after learning all of the pertinent details.
What are the pertinent details? Here’s a few:
Many tax planners know that tax law is scheduled to change in a big way when 2026 gets here, which may or may not actually happen but if nothing changes then it will.
A common assumption would be “I am in the 12% marginal tax bracket now and in 2026 I will be at 15%, therefore I should fill up the 12% bracket now with a Roth IRA conversion to avoid paying tax at 15% later”.
That sounds logical, but let’s look at an example where it is not a good deal:
Jack and Diane are both 65 years old and combined they receive $60,000 in Social Security Income and $30,000 in Pension Income. They take the standard deduction of $32,300 for 2024 and currently based on their income, only $19,600 of their $60,000 in Social Security benefits is subject to taxation. This leaves them with a total federal tax bill of $1,730 on a $90,000 household income which is an effective federal tax rate of 1.92%, not bad!
Jack realized that due to required distributions from IRAs in the future that they will trickle into the 15% marginal rate at some point after the tax law changes. He wants to convert as much as he can in the 12% bracket today and realizes he has about $44k of wiggle room to max it out.
He asks his bright financial planner at Meredith Wealth Planning about this and the planner says that a $44,000 conversion would add $8,930 to his federal taxes. Jack thinks his advisor must be wrong, because $8,930 is over 20% of the $44,000 converted amount and they are only in the 12% tax bracket.
The advisor shows him that adding $44,000 of income via a Roth conversion would increase his taxable Social Security from $19,600 all the way to $51,000. Therefore a $44,000 conversion takes his taxable income ~$75,000 higher!
Jack is pleased to know that his bright financial planner is looking at things he had not even considered and tells Mr. Meredith he should ask for tips like they do at Scooters Coffee.
I’m not sure these are still as widely believed as they once were, but I still hear it every now and then. With elevated home prices and mortgage rates increasing substantially I am starting to see more people itemizing due to their mortgage interest.
However, if a realtor tells you that your mortgage interest is deductible, they may or may not be right.
If you do not itemize your deductions, you are not deducting your mortgage interest on a personal residence. According to the IRS, only 10% - 14% of taxpayers still itemize, so odds are that most people are not deducting mortgage interest.
The same is true for charitable donations. Charitable entities often tout tax savings benefits to their potential donors, but outside of a qualified charitable distribution (QCD) from your IRA (which you must be 70.5 years old to do) you have to itemize to deduct your charitable donations.
That being said, most people give to charity to primarily support causes they believe in rather than worry about maximizing tax savings, and that is a good thing.
When we have clients with long-term charitable intentions and are not eligible for QCDs, sometimes we will recommend donor advised funds where a client can lump together many years of donations at once and itemize their taxes that year to take advantage of a deduction.
This one is tough, because like myth 3 it is highly individualized. Illinois does often get labeled as a high tax state, but to some people it can actually be a low tax state. I’ll explain.
According to the Tax Foundation, Illinois ranked 44th in 2022 on most tax friendly states, which would mean it's quite an unfriendly state for taxes. The neighbors just a few miles to the West in Missouri ranked 13th.
Having dealt with a lot of retirees in Illinois, many of them are actually getting a pretty good deal. Illinois does not tax pensions, Social Security, or IRA distributions. Since that covers the bulk of many retirees incomes, it is not uncommon for me to see retirees paying close to zero in state income taxes even on 6 figure+ retirement incomes.
Illinois does get you from other angles though. Sales tax is very high in this area, in addition to gas tax, and of course some of the highest property taxes in the country.
Take for example wanting to escape the high property taxes and winter months that Illinois offers, and relocating to Florida. In the aggregate, the median home value in Illinois is $432,500 with a median property tax of $9,006.07 while in Florida the median home value is $711,100 with a median property tax of $6,489.
If you are median person, do you want to spend about $280k more for a house to save $2,500/yr in property taxes? While the 0% state income tax in Florida is attractive, as I mentioned above it is not uncommon for retirees in Illinois to experience very low state income taxes. Plus, we have all read about the large increases in homeowner’s insurance premiums from Florida residents.
There are many reasons to relocate to a low tax state, but what you save in taxes may end up costing you more elsewhere.
Saving taxes may be an added perk of choosing a new place to live but if that's the only reason you are moving, you might be making an ill-advised decision.
Don't take it from me, Charlie Munger often said he wouldn’t move across the street to save his children $500 million in estate taxes.
Disclosures: This article is for informational purposes only and should not be considered a recommendation. Information contained in this article is obtained from third party resources that Meredith Wealth Planning deems to be reliable. Consult with a financial advisor before implementing any strategies.
A quick chat to get to know each other and learn more about what you're looking for in an advisor
We know that working with an advisor is a big decision, take some time & sleep on it
When you're ready, we get started with our planning process
.png){kind=small}