If you are making a six-figure income or seven-figure income, congrats! It's a great achievement to earn over $100,000 a year. However, there are tax penalties for high income earners that you should be aware of.
For example, you must pay a 6.2% Social Security tax for the first $160,200 as of 2023. Plus, 1.45% Medicare tax on unlimited income. This FICA tax income threshold keeps going up every year.
Then you have to pay a 3.8% Net Investment Income Tax on income over $200K for individuals and $250K for married couples. Further, due to tax reform, there is a $10,000 State And Local Income Tax (SALT) cap now. It's getting expensive making more money today!
Tax Rules Must Be Followed
Tax refunds are nice. Unfortunately, I don't always get one. When I first wrote this article, I didn't get one because I didn't pay quarterly estimated taxes despite my freelance income. 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. My freelance work was a new endeavor. But I enjoyed it 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
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. If you need more convincing, read this post on Do Your Own Taxes Or Hire A CPA?
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 example 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 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. Fortunately, most marriage penalty taxes have been abolished.
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. This is 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. Then make as much passive investment income as possible, especially 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 $160,200 in 2023. Every year the maximum income for FICA tax (Social Security + Medicare tax) should go up to account for inflation.
Your client and the government don't know about your other income earning activities until you file. Thankfully, you'll get a Social Security tax refund 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. That's 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
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 are in office, the “rich income level” tends to go up. In a funny way, Republicans might give society more stress by providing people an extra incentive to make more money.
After Trump's exit, I decided to take things down a notch after Biden got elected. With a larger social safety net and potentially more taxes, it's best to take things easier. This way, you have a higher return on effort.
The Most Tax-Efficient Income Amount To Earn
I'm much happier trying to make and maintain a $200,000 – $300,000 AGI than a $400,000 – $450,000 AGI. There's too much work and stress involved at the $400,000+ level. In fact, I think the best income to live the best life is about $300,000 for a married couple.
I've also noticed there's definitely not much more happiness between the two income levels, no matter what the latest gallup poll says!
With the median household income at roughly $75,000, shooting for a $200,000 individual and $300,000 household income. Don't bother killing yourself to make a lot more money. 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!
While you're at it, learn how to pay little to no taxes for the rest of your life. Manage your income to manage how much you owe in taxes. And if you're a smart investor who earns the best types of passive income streams, make sure you perform accurate passive income forecasting too.
Recommendations To Minimize Tax Penalties
Do Your Own Taxes And Save Money
There are many benefits to filing taxes by yourself. TurboTax makes it easier than ever. I've been filing my own taxes for over 15 years and couldn't be happier. And my taxes are complex!
Take a look at their latest offerings. TurboTax offer both free and affordable options to file your own taxes.
Manage Your Finances In One Place
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