The Tax Policy Center recently calculated most working Americans didn’t pay federal income taxes in 2020. According to the chart below, supposedly 106.8 million out of 176.2 million total income tax filers did not pay federal income taxes. That amounts to 60.6 of Americans don’t pay federal income tax!
Given there are roughly 332 million Americans, what happened to the other 156 million “tax units”? Well, the other 156 million are either children, retired, or too old to work.
Have a look at the data for yourself and tell me if you’re seeing what I’m seeing. The forecast for the percentage of Americans who pay federal income taxes increases in 2022. But we won’t know until 2023.
The Tax Policy Center also estimates that 57.1% of working Americans in 2021 won’t have to pay federal income taxes either. The reasons for the surge in non-federal income taxes payers are obviously COVID and the many tax credits the government introduced to help rescue our workers.
More than 20 million workers lost their jobs in 2020 with low-income workers hardest hit. When you add on refundable tax credits, such as the Child Tax Credit (CTC), the Earned Income Tax Credit (EITC), and stimulus checks, it’s easier to understand why 40% more working Americans in 2020 paid no federal income taxes.
The Future Percentage Of Americans Paying Federal Income Taxes
Perhaps what’s most interesting are the Tax Policy Center’s forecasts.
By 2022, the Center estimates 41.6% of Americans will not pay federal income taxes as the economy recovers. I believe this forecast is too aggressive given the percentage of non-payers has ranged from 42.4% – 44.7% from 2011 to 2019.
Here are the reasons why I think the percentage of Americans paying no federal income taxes will be between 47% – 52% for the next 10 years. I highly doubt only 37% of Americans will not pay federal income taxes as the Tax Policy Center predicts by 2031.
1) Once The Cat Is Out Of The Bag
Let’s look on the bright side. Millions of Americans have experienced the joys of NOT working. The people I’ve spoken to who’ve been able to receive enhanced unemployment benefits, stimulus checks, and tax credits have all greatly appreciated the support.
They’ve been able to spend more time with their family, play more midday tennis, and live a more balanced lifestyle. Some states even paid more in unemployment benefits than the median income.
In 2020, I could seldom get a tennis court at a public park between 10am – 1pm because so many of the restaurant workers and gig economy workers stopped working. One fella gleefully told me, “I love my new employer, the EDD (Employment Development Department)!”
When you’ve gotten used to a new, better way of living, it’s very hard to go back to the old way of living. Just look at the latest surveys from employees who’ve been able to work from home since March 2020. Any increasingly higher percentage of respondents wish to work from home forever.
2) Different Politics In Power
We’ve got President Biden in office. Therefore, we should expect continued bigger government programs to help more people, not less. The more government stimulus that’s provided, at the margin, the less incentivized people are to work.
Remember, we have to compare President Biden’s economic policies to President Trump’s economic policies when making federal income tax percentage forecasts.
Further, with President Biden’s approval ratings dropping due to the Afghanistan situation and the rise of the delta variant, there is a growing risk the Democrats will lose their majority in Congress after the 2022 elections.
Vice President Harris also seems to have lost her luster. Therefore, the Democrats will be incentivized to keep stimulus spending high thru the 2024 Presidential election.
3) Potentially Higher Taxes For All
To fund bigger government programs requires higher taxes and more deficit spending. Therefore, at the margin, higher-income earners will be less incentivized to work. These taxpayers will still be recorded as paying federal income taxes but simply be paying less.
However, there is a chance government spending gets out of control. If so, there may be higher taxes on the middle class and lower-middle class to help spread out the cost.
If this were to happen, fewer people will be incentivized to work as much. Therefore, there will be a lower percentage of Americans who will pay federal income taxes. Further, less Americans are willing to donate to charity because they are already being taxed so high.
4) A Growing Percentage Of Entrepreneurs And Freelancers
About 4.3 million new business applications were filed in 2020, almost 1 million more than in 2019, according to figures from the U.S. Census Bureau.
Compared to W2-income earners, entrepreneurs have many more ways to reduce their tax liability. For the first several years of a small business’s life, many pay little-to-no federal income taxes due to startup costs.
The number of sole proprietors and small business owners is expected to increase in the coming years. The general trend is for more people to want to work for themselves, not less. As a result, there should be fewer and fewer people who will pay federal income taxes, not more.
Perhaps You Should Also Stop Paying Federal Income Taxes
The Tax Policy Center and the Federal Government are painting a rosy picture about America’s economic future. However, the Center’s forecast that only 37.5% of working Americans will not pay federal income taxes by 2031 is way too aggressive.
Instead, I forecast we’ll hover in the 47% – 52% range for non-taxpayers for the next 10 years. There should be a structural increase in non-taxpayers, not a decrease. Just like in politics, the country will be almost equally divided between the payers and non-payers. And if you don’t pay any federal income taxes, you don’t have to feel guilty since many millionaires don’t either.
As a result, you may want to ask yourself whether or not you want to be one of the working Americans who pay federal income taxes to help support those who do not, or vice versa.
I’m assuming most of you would rather pay federal income taxes. If you do, that means you’re making at least the standard deduction limit of $12,550 for singles and $25,100 for couples after all adjustments. Living on less is difficult.
Further, I’m also going to assume you’re busy trying to generate as much passive income as possible to not have to work so much. At least your investment income will be taxed at a lower rate than W2 income.
However, if enough people prefer to pay no federal income taxes, there may be a growing amount of apathy towards policy. With no skin in the game, you may not care as much about making America a better country for all.
The Great Upside To Fewer Taxpayers
Before we had children, we went all over Europe multiple times. With higher unemployment, lots of government support, and higher tax rates, we were always amazed by how happy the Europeans seemed to be. It was probably mostly a mirage since we were tourists being greeted by people who were paid to make us happy.
Happiness Is Great
However, Europe is perennially home to the happiest countries in the world. And given happiness is a terrific end goal, perhaps America turning more into Europe isn’t such a bad idea.
Here are the happiest countries in the world according to the latest World Happiness Report.
- Finland (4th year in a row)
- New Zealand
More Wealth Is Nice Too
If we then look at our friends up north in Canada, they are doing very well. Canadians have a massive housing boom, subsidized tuition, and subsidized healthcare. Although their federal income tax rate is slightly higher than ours on the low end, the top Canadian tax bracket is only 33% versus 37% in America.
Canadians also have a higher median net worth than Americans, which means society is more equitable as well. Further, the growth rate of Canadian millionaires is forecasted to be almost triple the growth rate of American millionaires over the next four years.
Therefore, perhaps the Tax Policy Center and the Federal Government should not be forecasting such an aggressive increase in the percentage of federal income taxpayers over the next 10 years. Instead, they should be forecasting the opposite to promote more happiness and redistribution of wealth.
Living in a country with greater government support will make life easier for working Americans and their children. With a lower federal income tax burden, there may be more disposable income to invest for retirement or live a happier life in general.
Find More Balance Between Work And Life
We’ve read about how investment banking analysts are working 100 hours a week and completely miserable.
I’ve introduced to you couples who make $500,000 a year and hardly ever see their children. These people are not happy. And they number in the many.
Although Financial Samurai is a website that provides strategies to maximize wealth, this website also tries to encourage people to optimize for a better lifestyle. Don’t forget the end goal!
Of course, nobody wants to pay no federal income tax because they’re too poor to do so.
Instead, it’s probably best to always pay some percentage of your income to federal income taxes. Above a certain threshold, say 20%, is probably not worth grinding so much if you already make enough to provide for a comfortable lifestyle. Because don’t forget, you have to pay FICA tax and most likely state income tax as well.
A total all-in effective tax rate of about 30% is my threshold where work motivation starts to decline. After 50%, the incentive to work more should fall off a cliff for the vast majority of people.
Why bother working so hard if the government takes more than you get to keep? If you are then part of the ~50% who disagrees with the current political regime, then you will be even less motivated to work.
The Ideal Number Of Years To Pay Maximum Federal Income Taxes
I was OK grinding it out for 13 years in finance, paying six-figures in federal income taxes a year for most of those years. However, once the decision was made to raise taxes in 2013, I thought finishing up in 2012 was as good a time as any.
I was exhausted and didn’t want to work even harder to pay more in taxes (3.8% NIIT, 20% capital gains tax, 39.6 percent top marginal tax rate). Further, I longed to do something new.
I think the ideal number of years to grind it out is up to 20 years. After 20 years, you will tire or get bored of working so much. But you will also feel proud knowing you contributed for a long enough time to support this great country.
After 20 years of working to make the most money possible, you can then take it down a notch. Or, you might even want to take a long retirement. Just be prudent about planning ahead.
If you don’t want to pay higher federal income taxes, make a move. Complaining won’t get you anywhere. Although I’m likely poorer for leaving a well-paying job behind, I’m healthier and happier.
Recommendations On How To Pay Less Taxes
1) Start Your Own Small Business
I encourage everyone to start their own small business. You get a lot more flexibility with deductions as you can see in the example above. The best way to start a business is create a website like mine by signing up for a hosting company like Bluehost, which costs less than $4/month. You get a free domain name for one year too.
Once you’ve got your simple website up and running, you help legitimize your business. There’s no need to incorporate as an LLC. Just be a sole proprietor, report your income on your schedule C, deduct all your expenses, and pay taxes on your operating profit.
Whenever I spend money on travel, it is largely a business expense because I’m always prospecting for potential clients. I expense a portion of my car lease payment given I drive down to the Peninsula to work at my consulting clients. Many of my meals are also expensed due to client luncheons and dinners.
Finally, I contribute over $50,000 a year pre-tax to a Solo 401k because I run my own business. You can check out my step-by-step guide on how to start your own website today. Once you’ve got your own website, you’ve helped legitimized your business.
2) Invest In Real Estate
If you want to pay less taxes, you need to change the composition of your income more towards investment income. Earning stock dividend income and bond income are great because they face lower marginal income tax rates.
However, my favorite tax-efficient investment income is rental property income. Because you can deduct all rental property expenses, you can lower your taxable rental income. Further, amortization is a non-cash expense which also significantly reduces your tax liability.
After you have purchased enough rental properties that you can handle (four for me), invest in 100% passive private real estate funds like the ones offered from Fundrise. Fundrise manages over $2.5 billion and invests primarily in single-family and multi-family properties in the Sunbelt.
After I had my son in 2017, I sold my hard-to-manage rental property and reinvested $550,000 in private real estate. It’s been great to earn more passive income in order to spend more quality time with family.
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