Time for a look at our 2017 taxes! We paid a total of $49,501 in taxes across all types, with $26,254 going to income taxes. Taxes took 25.6% of our gross pay, which is exactly the same percent as last year.
The Silent 1/4 Partner
Most of what you pay in taxes happens automatically. Income tax is withheld from every paycheck along with Social Security and Medicare deductions. We never really think about what we’re paying because it never feels like our money. The only time we stop a moment is when we’re filing our annual return, but even then we only care if it’s a refund or balance due, not what we actually paid for the year. If you ask someone how much income tax they paid they’re likely to tell you how much their refund was; I’m willing to wager less than half of people know their actual liability.
I really think this is a result of the way taxes are collected. And it’s not happenstance, it’s a feature of the system. If automatic withholding didn’t exist there would be riots in the streets, or at least more complaining to co-workers. I go deeper into this idea in our 2016 tax update Wait, Where did 25% of Our Paycheck Go?
Ok, on to the 2017 Actual Numbers
The $26,254 in income tax is the total liability from our 2017 return. There is usually a lot of confusion around refunds and their desirability. Whether you get a refund or owe money is not synonymous with your income tax liability. A refund isn’t inherently good and a payment bad – those are cash flow concerns.
A large refund only means you prepayed too much; an amount owed means you didn’t prepay enough. If you get a refund your bi-weekly paychecks were smaller than they should have been; if you owe money your bi-weekly paychecks were larger than they should have been. It’s a timing issue, not a tax one.
Now that’s out of the way…
Wages, 401k’s, and Tax Deferral
Our taxable wages were $159,014. This is our gross income minus our 401k contributions (with a few other small items). Contributions to 401k’s are tax-deferred, meaning you don’t pay any tax now when you put it in, instead you pay tax later when you take it out. This is a great benefit for us since we’re high income earners. We both maxed out our 401k’s ($18k each), which “saved” us $9,000 in taxes ($36k x 25% – our marginal rate).
I do the quotes around “saved” because we will eventually pay tax on that, but the exact benefit is rather hard to pin down. It’s dependent on our tax rate when we withdraw the money and the effect of tax deferred growth. Tax deferred growth is just a confusing string of words that mean we get to invest the $9,000 that would have been paid in taxes and earn even more from it. When we pull the money out of our 401k all of it will be taxed, the $36,000 we put in plus any investment gains.
Our taxable income was $139,699. This is our taxable wages from above, plus $1,485 in dividends, minus our standard deduction ($12,700) and personal exemptions ($8,100). You may be wondering why we don’t itemize. Well that’s because itemized deductions are not a great deal, unless you’re rich. I’ll spare you the rant, but you should check out my post on why you should Stop Caring about the Home Mortgage Interest Deduction.
To actually answer why we don’t itemize… Because we paid off our house(!) we had only $981 in mortgage interest for the year. As far as other potential itemized deductions: we paid $4,182 in property taxes and $4,161 in sales taxes (which we could only deduct if we saved every receipt and kept great records). If we didn’t want to save all our receipts we could take the short-cut sales tax deduction from an IRS table, but it would be about half as much. We also gave $1,000 to charity, which rounds out our itemized deductions. The grand total is thus… $10,324. Since that’s less than our $12,700 standard deduction we took the standard.
Even if we did have a mortgage
Let’s pretend for a moment we didn’t pay off our mortgage early so we could keep the “tax benefits”. We would have paid around $5,000 in interest instead of $981, which would have bumped our itemized deductions to $14,343. Since that’s more than the standard deduction we would have itemized. But it’s only $1,643 more than the standard, which means it would only “save” $411 in taxes. What a boon…
Ok, income taxes are done – $26,254 – let’s move on.
This seems like a useful place to lay out some terminology. “Social Security” taxes are the 6.2% you pay to OASDI (Old Age, Survivor and Disability Insurance) to fund the monthly social security checks you receive when you “retire” or become disabled.
“Medicare” taxes are the 1.45% you pay to HI (Hospital Insurance) to fund the guaranteed health insurance provided to qualifying retirees.
Together OASDI and HI make up FICA taxes. FICA is an acronym for Federal Insurance Contributions Act. FICA taxes are often referred to as “Payroll Taxes” because they are automatically taken out of your pay.
In summary, OASDI = Social Security; HI = Medicare; FICA/Payroll Tax = both.
Social Security Taxes
You pay 6.2% of your first $127,400 in wages into OASDI and your employer pays an additional 6.2% on your behalf. If you’re self-employed you get to pay the whole 12.4% yourself, hooray!
The contributions fund your future retirement, or in IRS parlance Insurance for Old Age, which sounds more like a medical condition than an aspiration. The nice thing is the more money you put in, the more you get out, though it’s definitely not dollar for dollar. The benefit is very front-loaded, meaning as your cumulative lifetime earnings increase each dollar you pay into Social Security yields less future benefit. Social Security is progressive in this way, meaning it gives a greater proportional benefit to people who earn less money in their lifetime.
There’s no income limit for Medicare like there is for OASDI, but Medicare does have a surtax. If you make over $200,000 then every dollar over that gets an addition 0.9% Medicare surtax. Just like OASDI, your employer has to match the 1.45% Medicare tax on your wages; if you’re self-employed, you kick in the whole 2.9%.
Unlike OASDI, Medicare does not have progressive or proportional benefits. You either work enough to qualify for Medicare, or you don’t. Ok so it’s not quite that simple, but we won’t deep dive here. Essentially if you’re employed and pay Medicare taxes for 10 years, you’ll qualify when you become old enough or disabled.
If you work beyond 10 years you continue to pay Medicare, but you won’t receive any additional benefits.
We shelled out $4,182 in property taxes for our small suburban home. Soaring property taxes are an unstoppable force and one of the reasons rising home prices are not a good thing, even (especially) if you’re already a homeowner.
That’s all I got. Our total tax rate stayed exactly the same as 2016, which is no great surprise since we had no life changes. We shelled out $49,501 in taxes in 2017, which doesn’t even tell the whole story. There are even more hidden taxes and fees eating up our money. Things like gasoline taxes, taxes levied as part of our utility bills, FAA taxes on airline tickets, and multiple others.
Without digging into all my receipts I feel confident our actual tax contributions are over $50,000. That’s a big number. Certainly we receive MANY benefits that are related to these contributions, but I wonder what the actual value of our benefit is. I wonder how that could even be calculated. I mean at some point in our lives (non-working years) we’re going to pay in waaaaay less and receive even more benefit than we do now.
I’m not trying to use this post to complain about taxes, only to draw attention to how much of our money is actually going to taxes, being spent by someone else on our behalf. It’s interesting to look at, and something I’ll continue to do every year.
Hope this was thought-provoking at least. Thanks!