Higher interest rates are already a tax on consumers through higher mortgage rates, higher student loan rates and higher consumer loan rates. Is the economy strong enough to withstand a sudden ~30% increase in borrowing costs? Hopefully yes, since the actual rate we pay takes time to adjust higher, e.g. 5 years for a new 5/1 ARM to adjust.
Given the market determines rates, we can’t fully blame Donald for making borrowing more expensive for everybody. But what about Donald Trump’s plan to increase taxes on the middle class? Let’s learn what’s going on here and help find solutions for millions of Americans who are increasingly getting squeezed.
Below is a comparison on Trump’s tax plan versus the current plan. Can you spot the tax hike?
Individuals who make $112,500 – $190,150 will see their federal marginal income tax rate go up by 5%, from 28% to 33%! The closer you are to making $190,150 as an individual, I estimate the closer you are to paying ~$3,000 more in federal income taxes. The math is simply $190,150 – $112,500 = $77,650 in income now taxed 5% higher at 33% rather than 28%. Therefore, $77,650 X 5% = $3,882.50 more in taxes.
However, due to the the tax cut for income between $9,275 – $37,650 (15% to 12%) under Trump’s plan, you get a savings of about $851.25. Therefore, the Modified Adjusted Gross Income after deductions that is subject to taxes really is between $130,000 – $190,150.
Some of you might be thinking $112,500 – $190,500 isn’t a middle class individual income, but I absolutely believe it is for 50% of the country who live in expensive coastal cities and other large cities such as Denver and Chicago.
If we believe we shouldn’t responsibly spend much more than 3X our gross annual income on a home, then all an individual earning $112,500 – $190,150 can afford is a $337,500 – $570,450 home.
With the median home price over $1M in SF and NYC, you’ve got to earn closer to $330,000 just to buy something mediocre! Even with a $190,150 salary, you can barely afford the median $505,000 Boston home. You’re certainly stretching to afford a $594,600 median home in Seattle as well.
The Democratic rhetoric has recently been that any individual who makes over $200,000 is deemed rich and should be subjected to higher taxes. The Republican party rhetoric has recently defined individuals who make over $400,000 to be rich. Therefore, it is baffling there is a 5% marginal tax hike for those individuals who make essentially HALF these amounts.
Half of $200,000 (Democratic rich) – $400,000 (Republican rich) = $100,000 – $200,000. Half = middle. Middle = middle class. Why is the middle getting penalized?
Why The Tax Hike?
I’m not sure why Trump wants to raise taxes on the middle class. It’s good to hear he plans to abolish the Alternative Minimum Tax (AMT) and the 3.8% Net Investment Income tax on individuals/couples who make more than $200,000/$250,000. But those benefits accrue mostly to individuals who make more than $190,150.
It’s nice Trump plans to nix the estate tax (death tax) for individuals / married couples with more than $5.45M / $10.9M. Getting taxed again after you already paid taxes on your wealth sounds like robbery. But given most of us don’t plan to die within 4-8 years, any changes to the death tax don’t really matter because they’ll surely be changed again.
A 5% tax hike on the middle class and a 6.4% tax decrease on the top 1% income earners who make over $415,050 is not helping the majority of people keep their hard earned money. In fact, it’s estimated that the top 1% will enjoy ~50% of all the tax benefits.
Why aren’t more middle class people upset about this tax hike? Is it possible that most people making between $112,500 – $190,500 are simply unaware they will be paying more a year in taxes? Or maybe the middle class is actually doing just fine and is happy to pay higher taxes? You tell me savvy readers.
After surveying more than 25,000 of you (!), more than 45% make over $100,000 a year and will likely be paying more taxes.
Below is a realistic budget for a single father with a child. He works at Mega Corp and will see his year-end money buffer decline to only ~$2,000 a year after paying ~$3,700 more in income taxes under the new Trump tax plan. One miscellaneous expense or mishap and he’s in the red.
Below is a more complicated example of a single mother with two children earning $200,000. She saves 15% of her gross annual income a year through her Solo 401k. Her biggest expenses are childcare assistance and healthcare, which is spiraling out of control for those who have to pay 100% of the monthly premium. I’ve estimated her effective tax rate goes up by 3% after Trump’s tax hike, leaving her in the red each month.
Before you complain about the accuracy of the numbers, they are just rough estimates. Each person has different deductions allotted to them. The bottom line in that the closer you get to $190,150, the closer you will pay the $3,882 in increased taxes. The 3% tax savings on income between $9,250 – $37,650 is only $852. If you want to save on taxes, you really shouldn’t make more than ~$130,000 per person.
The Solution To Lowering Your Taxes
If you are one of the millions of Americans who is facing an impending 5% federal income tax hike, your solution is to get married and make no more than an modified adjusted gross income of $225,000 combined. This way, you can keep on paying a 25% federal marginal income tax rate and benefit by paying 3% less than the existing system on income between $151,900 – $225,000.
Under the current tax plan, household income between $151,900 – $231,450 is taxed at a 28% federal marginal income tax rate.
Here are some sample marriage income combinations for the perfect tax minimization solution:
1) Stay At Home Spouse
Spouse 1: $225,000 income
Spouse 2: $0
2) Two Professionals Who Met At Work
Spouse 1: $115,000
Spouse 2: $110,000
3) Public School Teacher And Private Industry Professional
Spouse 1: $55,000
Spouse 2: $170,000
Of course, you can make more than $225,000 by the amount equivalent to your mortgage interest deduction and property taxes. If you run your own business, you can make more than $225,000 by the amount equivalent to your expense deductions.
The key is to not stay single. It’s bad enough you’ve got to compete with DINKS, and DINKS + their parent’s money to buy a home or pay for other big ticket items. To add on higher borrowing costs and pay higher taxes is just too cruel.
My Solution To Paying Less In Taxes
As an individual, I’ve either got to kill myself to try and make as much as possible over $415,050 to take advantage of the new 33% marginal federal income tax rate. Or, I’ve got to limit my individual adjustable gross income to $112,500 to pay a reasonable 25% marginal federal income tax rate.
Which is harder to do?
The Strategy For Making Less
Because ~70% of my traffic on Financial Samurai is from search engines like Google, the traffic is very passive. In other words, if I do nothing all year my online income would still be greater than $112,500, the individual income level where taxes go up from 28% to 33%. Passive income is one of the beauties of having an online asset. I just write a lot because it’s fun and there’s always something interesting going on to learn about.
I could sell all my dividend paying stocks and hold cash, but that still leaves about $180,000 in passive income that cannot be reduced immediately because there’s an early withdrawal penalty for CDs, tenants with signed leases, and private investments with multi-year commitments.
One solution is to just sell Financial Samurai once new tax legislation passes and call it a nice eight-year run. That way, I’ll have no more taxable online income. Let’s say I can sell Financial Samurai for $10,000,000 after taxes. I can just hoard cash earning 0.2%, which equates to $20,000 a year. $20,000 + $180,000 in passive income = $200,000. I can then deduct about $40,000 in property taxes and mortgage interest from my primary residence to get to a $160,000 taxable income.
As time passes, I can slowly convert all passive income assets to cash, thereby further lowering my income. Paying taxes on <$160,000 equates to about a 26% effective marginal federal tax rate under the new plan. Not too unreasonable, especially if I can just plunder my cash to live.
Of course, I can actively give money away to reduce my taxable income further while helping other people in the process.
The Strategy For Making More
Making a lot more than $415,000 is not easy. But it’s possible with some planning and extra labor.
1) Don’t sell Financial Samurai, but continue to grow it. Minimum $150,000 income.
2) Keep passive income portfolio as it is. Minimum $200,000 income.
3) Do more corporate consulting. Minimum $120,000 income.
4) Do more 1X1 personal finance consulting. Minimum $30,000 income.
5) Get a J.O.B. Minimum $150,000 income.
Total baseline income = $650,000
Unfortunately, doing 3, 4, and 5 will require an extra ~50 hours a week, which means my total weekly work hours would sky rocket to 70+. I’ll also gain weight, get stressed, start getting gray hairs again and be more bitter at the world.
The tax savings from making $650,000 would equal ($650,000 – $415,000) X 6.4% = $15,040. When I put it this way, working an extra 50+ hours a week to “save” $15,040 in taxes doesn’t seem worth it at all! Further, at $650,000, I’ll have to pay 13.3% California State taxes instead of “only” 10% on income up to $250,000.
The reality is, if my baseline income is $350,000 ($200K passive + $150K online income) for ~20 hours a week and I add 50 hours a week to get to $650,000, I’m really paying ($650,000 – $350,000) X 33% = $99,000 more in federal income taxes. It’s the whole “buy more save more” mental scam. Given I’m already paying over $100,000 a year in total taxes, paying another $99,000 a year in federal taxes + another $53,200 in state taxes would actually start to piss me off.
It seems like highway robbery to have to pay over $250,000 a year in taxes when you’re killing yourself and not using massive public resources. And for what? To one day live a better life that’s more free and less stressful? I’d rather just kick back, pay less in taxes, and be free right now! After all, happiness does not increase with an income over $250,000 a year.
Obvious decision made: It’s much better to go the easier route by making less money to pay less taxes and live more freely. I believe in enjoying life to the maximum because I’ll never be able to make another minute of time. I know plenty of deca-millionaires who are no happier than an average person still looking to save for retirement.
For those who object to going the easier route, answer me this: Are you willing to work 50+ more hours a week to try and make $300,000 more just so you can pay $100,000 more in taxes? If not, then you’ve caught yourself in an incongruent state of mind.
Middle Class Americans, STAND STRONG!
Being middle class is the best class in the world. But we’re now getting squeezed by higher taxes and higher interest rates. First the government wanted to raise taxes on those making over $400,000 a year. Then they went after individuals making over $200,000 a year. Now they’re going after folks making over $112,500 a year. See the pattern? Eventually, the government will come for us all. Everybody needs to make some pro forma calculations of their annual total income and decide how hard or how smart you want to work.
The only beneficiary of higher interest rates and higher taxes I can think of are those who take advantage of the sell-off in municipal bonds. As more individuals making $112,500+ a year see their taxes jump from 25% to 33%, there should be more demand for tax advantageous instruments, not less. If you know of other beneficiaries, please share.
If you aren’t maxing out your 401k, definitely start doing so ASAP to shield as much income as possible from the impending tax hike. You’ll be amazed at how much you can accumulate if you stick to the program. Max out for 10 years in a row and you should easily have over $200,000 for retirement.
If you’re crazy enough to want to earn a lot more than $415,050 a year to take advantage of the proposed 6.4% federal income tax cut, make sure you actually succeed in making a lot more than $415,050. The worst thing is to work 24/7 and only make ~$190,150. The government will laugh in your face because they’ll have successfully minimized your use of government resources while taxing you to the maximum!
Finally, if you’re a $112,500+ a year earning individual, start going to charm school. Not only will you save on taxes, you’ll help eradicate loneliness, save on shared living expenses, and have a confidant to share all your hopes and fears!
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Updated for 2019. Trump’s tax plan is going to hurt coastal city income earners the most due to the SALT deduction cap of $10,000.