Updated for 2019 and beyond.
You must pay a 6.2% FICA tax for the first $128,700 + 1.2% Medicare tax on unlimited income + a 3.8% Net Investment Income Tax on income over $200K/$250K. Further, due to tax reform, there is a $10,000 State And Local Income Tax cap from unlimited before. It’s getting expensive making more money today!
Tax refunds are nice. Unfortunately, I won’t be getting one given I didn’t pay quarterly estimated taxes in 2014 despite my freelance income. So why didn’t I pay quarterly estimated taxes given there’s a likelihood I’d pay a penalty if I did not?
Uncertainty and certainty.
I was uncertain whether I’d freelance for the entire year. After spending most of 2012 and 2013 working on my own business, adding 25 hours a week of freelance work was a new endeavor. But I enjoyed freelancing so much (and didn’t get fired) that I decided to commit to at least a whole year. Furthermore, my consulting client was kind enough to offer stock options, so I had an added incentive to stay for at least the one year cliff.
What I was certain about was earning a higher W2 income since my online business kept growing. When it comes to estimated taxes, my accountant suggests following the safe harbor rules and paying 10% more than the previous year’s tax liability.
By doing so, even if you earn a much higher percentage in the current year, you’re safe from having to pay penalties and fees of any underpayment. If you’re unsure about your business outlook, to be safe, it’s advised to pay at least 90% of your prior year’s tax liability.
DO YOUR OWN TAXES AT LEAST ONCE
For over 10 years in a row I’ve been doing my own taxes with H&R Block’s tax software. Tax software is so good nowadays, anybody can and should do their own taxes at least once to understand all the nuances. You’ll learn about all the various forms, tax rates, deductions, credits, and tax laws. Every year I learn something new, and this year is no different.
By doing your own taxes, you also begin to naturally get smart about all the hollow proposals from our politicians. You begin to question how never-ending promises will get funded, who’s left holding the bag, and how to adjust your lifestyle so you aren’t constantly getting mugged.
In this post, I’d like to highlight some various tax penalties you must pay if you earn over $200,000 as an individual or $250,000 as a married couple. If you’re not at such an income level yet, now you’ve got a healthy income target to shoot for. If you’re killing yourself at higher income levels and want to take it down a notch, do it. Your life will get better.
Once again, $200,000 – $250,000 a year proves itself to be the ideal income for maximum happiness.
ADDITIONAL TAXES FOR HIGH INCOME EARNERS
Have a look at this hybrid model income earner who makes $177,978 from a day job (W2) and and $57,383 from freelancing (1099).
Additional Medicare Tax
As you can tell from the H&R Block screen shot above, there is a 0.9% additional medicare tax for individuals with AGIs over $200,000 and married couples with AGIs over $250,000. The reason why $200,000 + $200,000 = $250,000 for married couples and not $400,000 is because the government is either sexist or just too inept to recognize that times are different. They believe that two high earning individuals cannot continue to earn their wages once married. One spouse must give up a job to stay at home and do nothing or raise kids, even though plenty of couples don’t have kids.
In the example above, this person must pay an additional $318 a year in Medicare taxes given he earned $35,361 above $200,000. This isn’t a huge amount, but it’s still additional taxes that keeps on going up the more you make.
Net Investment Income Tax
In the above snapshot, you learn that there’s an ADDITIONAL net investment income tax rate of 3.8% for all investment income if you make more than $200,000 as a single individual and $250,000 as a couple. The extra tax bill is $978, meaning this person has investment income of $978 / 3.8% = $25,736.
Net investment income includes dividends and CD interest income. Ideally, you want to earn a perfect $200,000 as an individual and make as much investment income as possible, especially dividend income since it is taxed at a lower rate.
One of the biggest reasons not to be self-employed is that you have to pay BOTH SIDES of the FICA tax: 15.3%. Employees usually only pay half the 15.3% while the employer pays the other half. What’s worse is that if you have to shut your business down, you might not even be able to collect unemployment insurance.
Let’s say you make $100,000 consulting for one company and another $100,000 consulting for another company. You will pay Social Security tax on the full $200,000 income even though the maximum taxable income for Social Security is $117,000 in 2014 (goes up to $118,500 in 2015) because your client and the government doesn’t know about your other income earning activities until you file. Thankfully, you’ll get a Social Security tax refund back when you file.
Alternative Minimum Tax
Unlike the additional medicare tax and net investment income tax, there is curiously NO clear threshold as to when AMT strikes. If you have one, please share in the comments below.
In this example, a person making roughly $250,000 AGI and $180,000 in taxable income after $70,000 in deductions (mortgage interest, property tax, business expenses, pre-tax retirement contribution) still has to pay an AMT amount of $6,107. $6,107 is an ass kicking that accounts for 3.4% of the person’s taxable income.
If the person had an AGI of $200,000 and taxable income closer to $130,000, the AMT would decline by more than half. Based on plugging in various taxable income numbers, I’ve come to the conclusion that you’ve got to make under $100,000 in taxable income to avoid AMT.
MANAGE YOUR INCOME TO MANAGE YOUR TAXES
President Obama thinks every individual making above $200,000 a year is rich, regardless of location. This is why there is legislation in place to penalize individuals making over $200,000 a year and married couples making over $250,000 a year. We all know that $200,000 for a household isn’t exactly living it up in expensive coastal cities.
It’s important to understand the opinions of our politicians on who is considered rich. If Republicans win the executive office on Nov 8, 2016, then the “rich income level” is probably going to rise to at least $400,000 for individuals (current top tax bracket for 39.6%), and perhaps all the way up to $1 million. In a funny way, Republicans might give society more stress by providing people an extra incentive to make more money.
I’m much happier trying to make and maintain a $200,000 – $250,000 AGI than a $400,000 – $450,000 AGI. There’s too much work and stress involved at the $400,000+ level. I’ve also noticed there’s definitely not much more happiness between the two income levels, no matter what the latest gallup poll says!
Given the issue in Indiana with the Religious Restoration Freedom Act, I’m willing to bet that a Democrat wins the Presidency again. What do you think?
With the median household income at roughly $52,000, shooting for a $200,000 individual and $250,000 household income is a nice goal for those who make less. Don’t bother killing yourself to make more. The government will just tax you more than you can save.
Based on my Financial Samurai income poll, roughly 21% of individual readers make over $200,000 and 26% of married couples make over $250,000, so surely there are some of you who have opinions about these extra taxes!
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Updated for 2019 and beyond.