Springtime symbolizes renewal and new beginnings. How ironic that this season is when we’re required to file our taxes and look back at the previous year’s finances. In this episode of the One for the Money podcast, I share why not only is assessing our tax strategies essential but also assessing the tax code in general. Listen to the end when I share a strategy regarding significant tax savings that could be hiding in your 401k.
In this episode...
- The electric vehicle tax credit [02:07]
- Standard vs. itemized deduction [04:01]
- The deductibility of state and local taxes [06:01]
- The progressive nature of the tax code [09:24]
- Fairness and unfairness in the tax code [10:48]
- Tax advantages hiding in a 401(k) [12:20]
Who fairs fairer?
Many question the fairness of the tax code. While it’s anything but fair, you may be surprised by who does and does not benefit. The common argument is that people should pay their fair share. But change is constant in the tax code, as is the refrain about making the tax code fair. Here are a few examples that show who benefits and who does not.
First, let’s consider the electric vehicle tax credit. The federal government provides a $7,500 tax credit to people who buy an electric or hybrid vehicle. A tax credit is way better than a tax deduction because a credit is dollar-for-dollar elimination of taxes that would otherwise be paid. So if someone purchased a $200,000 electric vehicle that qualifies, they would pay $7,500 less in income taxes. While this is a significant tax break to the purchasers of these vehicles, is it fair that people who purchase gas-powered vehicles pay more taxes?
Taxes for homeowners vs. renters
When filing taxes, we can choose the standard deduction or the itemized deduction, which is the base amount of income on which you pay $0 in taxes. If you have items that add up to more than the standard deduction, you would take that amount in 2023. The standard deduction for an individual is $13,850; for a married couple, the deduction is double that amount.
The itemized deduction is where the questions of tax fairness come into play. One major contributing factor to one’s itemized deductions is the ability to deduct the interest paid on one’s mortgage. Are homeowners more virtuous than renters? If mortgage interest is deductible, but rent isn’t, then renters are required to pay more taxes and subsidize property owners. Is that fair? On average, homeowners are from the middle and upper-income tax brackets. Is it fair that poor renters provide a benefit for richer owners? The mortgage interest may incentivize some to purchase a home, though that’s debatable. Is it fair for the government to tip the scales in a homeowner’s favor versus a renter’s?
Plan to make the best of it
As you can see, there isn’t anything simple about tax matters. What about the progressive nature of our tax code? Those with higher incomes have to pay a higher dollar amount in taxes and a higher percentage. On average, higher earners pay a higher percentage than those who earn less. According to data from 2018 on the top 1% of US taxpayers, those who earned more than $540,000 per year made 21% of all the US income but paid 40% of all the individual federal income taxes. The top 10%, those who earned $152,000 or more, made 48% of the income but paid 71% of federal income taxes. The bottom 50% of earners, earning $43,600 or less, made 12% of the income and paid 3% of all the income taxes.
There are many other examples of fairness or unfairness in the tax code. Most would agree that the tax system in the United States is complex, confusing, and inefficient. The point of this podcast is to show that the critical thing is to focus on your tax planning rather than trying to determine whether the tax code is fair or not. Understanding the tax code and implementing better tax planning strategies will lead you to pay taxes better. Strategies to consider could take many forms, such as Roth contributions or conversions in low or lower-income periods. It could mean deductible retirement contributions during higher income periods, HSA contributions, or other strategies I highlighted in previous episodes.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
Securities and Advisory services offered through LPL Financial. A registered investment advisor. Member FINRA & SIPC.
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