Who Doesn’t Pay Income Tax? Who Doesn’t Want To?

Posted by Madison on August 8, 2011
46.4% of Households Will Pay No Federal Income Tax for 2011

Pay No Federal Tax

source: Tax Policy Center

In 2011, almost half of the households won’t pay any federal income tax. This chart strictly reflects federal income tax; it excludes states taxes and payroll taxes, including social security taxes. In addition, it’s people legally paying zero income tax, not those who aren’t reporting all their income.

Let’s take a look at what’s going on and see if we can’t learn something about reducing our own tax liability.

Large Incomes Paying Zero Tax

We know that many households don’t make enough money to pay tax, but let’s take a look at the top 10% of earners. There’s a table showing how many aren’t paying tax by income level. Check out some of the numbers:

Income levels of the top 10% and number of filers paying zero tax:

  • $163,173 – $210,997: 57,000
  • $210,998 – $532,612: 78,000
  • $532,613+: 27,000

That’s 162,000 households paying zero tax… on large incomes. Obviously there’s some substantial tax planning going on there, let’s dig a little deeper…

Which Tax Credits Do They Use?

A supplemental Tax Policy Center paper that explains in depth who doesn’t have to pay tax and which tax credits (if any) they are using to bring them into the zero tax category can help us all with some tax planning.

In lower income tax brackets, the credits utilized are for the elderly or low income working families with children.

However, when you analyze the higher tax brackets, there is a significant shift to using the following tax reducers and eliminators:

Next Steps

I’m seriously considering taking up the challenge in 2012 to become one of the households with a zero tax bill. (It’s too late for 2011.) What do you think, do you want to attempt it with me?

Are you a zero tax bill household? If so, what strategies are you using?



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Comments to Who Doesn’t Pay Income Tax? Who Doesn’t Want To?

  1. I am in the middle range of incomes you indicated and, like many, am unhappy with the amount of income tax I pay. I am more unhappy with the unpredictability (i.e., AMT) than the amount. I don’t think it is responsible, when thinking of the future of our children and this nation, for those of us with means to plan for zero income tax liability. I’ll do all I can to manage my bills, spending and debt, to time my estimated tax payments and charitable contributions and to maximize permitted deductions, but I will not strive for zero income tax liability. Your statistics do, however, bolster the argument that our tax code needs to be changed to give us all more predictability and to make sure those with incomes similar to mine are contributing positively to the long-term health of our nation’s finances.

    sorisobel

  2. It’s easy to reduce your tax liability to zero – just quit your job! Seriously though, I would think that you want to focus on maximizing long-term net worth. Consequently, focusing on minimizing taxes without considering the return on your investments would be as silly as … well, focusing on return exclusively without considering tax implications. Certainly take advantage of all tax deductions and benefits that you can, but once you reduce your taxable income into the 15% tax bracket (about 70K for married, joint), you really face a point of diminishing returns. For example, munis offering tax-free income are a favorable solution to counteract income that would otherwise be taxed at 35%. However, if the income would otherwise be taxed at 15%, then taxable bonds probably outperform.

    Managing Partner

    • You have a really good point! In fact, if I can pay tax in the 15% bracket, then I’d want to convert as much IRA money to Roth IRAs to fill out that bracket….

      so you’re right, while it would be an interesting challenge, from an overall net worth perspective, it would be counterproductive.

      Madison

  3. Some time ago you wrote, in the link above: “Why on earth would you be entitled to not pay tax, when millions of other Americans have to? I can only assume that my taxes are higher to account for all of those who do not pay their fair share.”
    Looks like now you think it’s OK to not pay the tax – at least, the federal income tax. It would be interesting to know what changed your mind.

    SM

    • Hi SM,

      Thanks for the comment. I think we are talking about two different topics: illegally cheating on taxes vs. legally minimizing taxes.

      The post you are referencing above was about someone cheating on their taxes and not reporting income. Essentially, breaking the law, and not paying their fair share based on what our laws require.

      What I’m referencing here is a challenge to see what legal tax deductions are available to minimize taxes.

      Hopefully that clears it up as I have not changed my mind at all, as I think there is a very clear difference between cheating and following the law.

      Madison

      • What’s the difference? You say it’s wrong because he’s not paying “his fair share” while the others do. How does it matter – from the moral point of view – if it’s technically legal or not? If he had found some legal loophole that allowed him to do the same – would it suddenly stop being “not paying tax while millions of Americans do”? Would it stop being “not paying your fair share”? It would not.
        I think there’s absolutely no difference from the moral point of view in not paying taxes because you found some loophole and just not paying taxes (with the same income and same situation) because you didn’t bother to find the loophole. It’s different legally but morally if you consider it’s fair for a person with certain income to pay certain sum (I don’t know how can you know that but suppose you do) I don’t see what changes if he finds some law that allows him to avoid doing that.
        As for breaking the law, US history knows many laws that were unjust, unfair and sometimes outright morally repugnant. People broke them, and some of these are lauded as heroes now. I’m not saying it’s the case with tax law, but the argument “it’s the law, so it must be fair to follow it and morally wrong to not follow it” obviously does not apply. Laws should be based on morals, not the other way around. So if you want some moral basis for paying or not paying the taxes, the law can not be it. And if it can’t – I still wonder why you think it’s OK for you not to pay the tax but not OK for your service provider. Is it just because some politician made a loophole for you and not for him?
        Sorry if it sounds confrontational, I don’t mean to offend you. I just think this question deserves serious consideration and discussion, if you plan to take the “pay no taxes” road.

        SM


      • SM,

        You have a very good point, and I think discussion is a very good thing, it makes us all better, and to see views we haven’t seen before.

        I was honestly just coming at it from a purely mathematical standpoint to see how one could lower their tax bill that much, but now that we’ve gotten into some of the morals, we’ve probably opened a can of worms!

        Let’s say both of us (my service provider and I) make $50k. They just don’t report it, and pay zero tax. I report mine, but then subtract a 401k deduction, my mortgage interest, my 3 kids, etc) and pay zero tax.

        Obviously, a totally oversimplified example, but you do have a point, why is it OK that the politicians said that I can pay zero tax, but my service provider can’t (because they don’t save for retirement, rent instead of pay a mortgage and don’t have any kids)? We both made the same amount of income?

        So you’ve definitely given me something to think about, “fair share” might not be a correct description. I’m going to have to think about this one…

        Anyone else care to weigh in on this one?

        Madison


      • “Fair share” implies everyone draws benefits and services equally. In some cases, such as defense, they do. In some cases, such as education and health services, they don’t.

        Tyler


  4. I respect SM’s commitment to morality, but I think he/she makes a few misapplications.

    In the Judeo-Christian tradition, we are morally bound to “render unto Caesar that which is Caesar’s” according to the letter of the law–plain and simple. While we obey laws and governments for moral reasons, laws and governments are not moral but legal entities, and we interact with them on a strictly legal basis. (Imbuing laws and governments with moral authority is highly dangerous!)

    Imagine you ate a meal at a 3-Michelin-star restaurant, and the server brings you a properly calculated bill for $10. While your meal may have been worth $100 to you, your moral accountability ends at $10. Sure, you will probably leave a $90 tip, but that is a beautiful expression of appreciation and generosity, not a moral imperative, not “being fair.”

    Likewise, when you calculate your taxes, taking all applicable deductions and credits, if the final total seems too little for all the valuable services your government renders to you, then, by all means, feel free to skip a deduction or two. But call it what it is–a generous donation–not being moral or fair.

    Please people, let’s not subvert our opportunities to nobly choose virtues of generosity and grace by painting them over with drab colors of duty and fairness.

    Bill

  5. By the way, when a loophole exists in tax law, and someone takes advantage of it, who’s to blame?

    I’m going to stick my neck out and say the law writers are to blame. Fix the law–that’s what’s broken. Don’t misdirect your anger at people who interact with it legally. In fact, you can thank them for being a corrective influence. If loopholes never leaked, sloppy laws would never get fixed.

    At the end of the day, we are all required to adhere to the LETTER of the law, not some subjective, nebulous sense of “fairness.” If tax laws don’t have the desired outcomes, they need fixing.

    IMO, the only really fair tax code would be a simple national sales tax, minus food. No loopholes there!

    Bill

  6. When a taxpayer with such a large income does not end up paying any taxes, there are usually several reasons:
    -Active losses from businesses, including K-1’s from s-corps and partnerships
    -Sales of business properties at a loss, such as a real estate professional that sold a rental building at a loss, and there is no limitation on the deductibility of the losses. Regular capital gains generally only offset $3,000 of ordinary income
    -Capital loss carryforwards
    -NOL’s (net operating losses)
    -Tax-free muni-bonds
    -Itemized deductions such as large charitable contributions and interest deductions
    Based upon my experience, most taxpayers are not able to implement these strategies to the extent of not having to pay any income taxes. Some of these taxpayers have huge income tax liabilities in one year and little to none in the next.
    Yes, tax planning is very helpful, but it produces the best and most dramatic results for business owners, real estate professionals, and investors, not the average taxpayer. Is it fair? I’m not sure. Is it fair when someone receives the earned income credit every year and never pays a dime of income taxes just because they don’t make a lot of money? My observation is that their income is very controllable, on the low side.

    Joseph

  7. And what % of the 46.4% not only do not pay federal income tax but as a result of various credits (child credits, earned income credit) get a paycheck from the federal government each tax season?

    Don’t get me wrong. I am not implying that there is not work to be done on the top side of the income tax laws as well.

    Stephanie

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