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3 Reasons the Tax Man Still Hasn't Set You Free

April 15 has come and gone, and most Americans have fulfilled their duty to the IRS for the year. But even with that task behind them, American taxpayers still haven't managed to earn enough money this year to pay off all the taxes they'll owe in 2013.

The nonprofit Tax Foundation came up with the concept of Tax Freedom Day to make it clear just how long Americans have to work just to pay their overall tax burden to federal, state, and local governments. The concept is simple: When you take the total amount of all the taxes that people have to pay and then divide it by their income, you can figure out what percentage of the year you spend working to earn enough to pay your share of those taxes.

This year, Tax Freedom Day for America as a whole won't come until tomorrow, April 18. That's five days later than it was last year. Let's look at three of the reasons why you still haven't managed to get free of the tax man this year, and why things could get even worse in the future.

1. Higher payroll taxes on Social Security.
At the beginning of 2013, the temporary tax holiday on Social Security taxes expired. As a result, payroll taxes rose from 4.2% to 6.2%.

Because Social Security taxes apply only to a maximum of $113,700 in earnings for 2013, not everyone saw their overall taxes go up by 2 percentage points. But for those who fall under that threshold level, paying 2% more of your income toward payroll taxes effectively means that you're working more than an extra week this year to get them paid.

2. Higher marginal rates on high-income taxpayers.
Even though high-income taxpayers don't bear the full brunt of higher payroll taxes, they don't get off scot-free. Increases in the highest marginal rates for single taxpayers making $400,000 or more and joint filers with more than $450,000 in income amount to 4.6 percentage points for ordinary income and 5 percentage points for dividends and capital gains.

Those higher rates only apply to the amount of income above those threshold levels, so taxpayers won't have to work 4.6% to 5% of the year paying their extra share. But taxpayers with incomes substantially above the thresholds can expect to work several extra days to pay it off, with some extreme cases involving two weeks or more of extra work.

3. New tax surcharges on high-income earners.
Moreover, high-income earners face some brand-new taxes this year. For single filers earning more than $200,000 and joint filers above $250,000, two new tax surcharges could increase your tax bill. For wages and other employment income, a 0.9% tax applies to amounts above those thresholds. Moreover, if you have investment income that when added to your other income puts you above those levels, you'll have to pay an investment-income tax of 3.8%.

Again, how much those taxes will add to individuals' tax burden depends on their exact income breakdown. But for many high-income earners, the taxes could add days or even a week or more to the length of time they work for Uncle Sam.

What's coming
Moreover, more tax increases look likely to hit ordinary Americans in the near future. Amazon.com (NASDAQ: AMZN  ) has been making agreements with an increasing number of states to collect sales tax on online purchases, and a federal law could subject Amazon, eBay (NASDAQ: EBAY  ) , and other online sellers with the obligation to collect taxes. That has helped Best Buy (NYSE: BBY  ) and other competing brick-and-mortar retailers, but it means consumers pay more in overall tax. Technically, most taxpayers already owe uncollected sales taxes to their respective states, but few states enforce those provisions vigorously. With state and local sales taxes representing 12 days' worth of the average American's tax burden, increases would have a small but significant impact on many people.

So when tomorrow comes, be sure to celebrate your freedom from taxes for another year. But as you start to earn money for yourself, keep in mind that you could be working even longer for the tax man in 2014.

Will sales-tax collection hurt Amazon? Read The Motley Fool's premium report to learn what's driving the company's growth and get filled in on reasons to buy and reasons to sell Amazon. The report also has you covered with a full year of free analyst updates to keep you informed as the company's story changes, so click here now to read more.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.


Read/Post Comments (6) | Recommend This Article (5)

Comments from our Foolish Readers

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  • Report this Comment On April 17, 2013, at 11:00 AM, DoctorGrumpus wrote:

    How on earth does a fixed-rate tax such as social security have any impact on this (so-called) "Freedom Day" from the Koch-controlled Freedom Foundation?

    What would make a really interesting article? The differing "Freedom Days" based on what income decile one is in.

    And can we please avoid such obvious propaganda techniques as "Freedom Day," since apparently unless it's on January first, we are living in tyranny (TM).

  • Report this Comment On April 17, 2013, at 12:19 PM, TMFGalagan wrote:

    @DoctorGrumpus - When the fixed-rate tax goes up, it has an impact on how much tax you pay.

    As for your request, stay tuned this weekend, as I'm planning to look at exactly that question (by quintile rather than decile).

    best,

    dan (TMF Galagan)

  • Report this Comment On April 17, 2013, at 1:23 PM, Darwood11 wrote:

    Of course, the marginal tax rate is more interesting. After all, most hedge fund managers are at a lower rate the the guy who drives the taxi and a physicist, to paraphrase Mr. Munger. I think the president and Ms. Obama pay just a bit more as a percentage than I do and yet they earned far, far more than my spouse and I did this year.

    There are a lot of legal ways to game the system, such as allowing parents to write off part of the tuition as a gift or donation to that private school is another way to avoid taxes. Private schools will say "It wasn't tuition" but it was part of the income necessary to run that school. Is all of this fair? Of course not. But that's the way it is. A lot of people will say "Well, everyone does it." Baloney!

    The fact is, we don't like to pay taxes, the tax code is unfair, and there are millions upon million of tax cheats among us according to the IRS. We all know this and if you don't then we're all either honest men and women, or we're all liars. Just about all of us buy something tangible on the internet each year. In those states that require self determination of sales tax, how many of us did it on April 15th?

    There is also the misconception among some that "A corporation never has, does not now, and never will pay a penny taxes." This may simply be one of a number of excuses that can be used to justify cheating on taxes.

    One thing that we sometimes overlook is the impact on "entrepreneurs" by this code. Anyone who wants to start a bona-fide business discovers that their income as wages will be taxed at the "self employed" rate which is double what the typical employee pays in SS and Medicare taxes. So what would you do? Get a 36 number as a tax ID, an accountant, pay those fees and fill out those quarterly returns to the state and the IRS, or simply pocket it all and go underground? It's easy to say "Hey, I can keep all of it or pay about 30% in payroll taxes, income taxes and accounting fees." Which would you do? Apparently many have decided to keep the money and run.

  • Report this Comment On April 19, 2013, at 7:06 PM, badnicolez wrote:

    I wonder what most people would do if they had no (or very few) deductions like some of us. I guarantee they would stop voting for higher tax rates.

  • Report this Comment On April 20, 2013, at 7:54 AM, devoish wrote:

    "A vivid, calendar based illustration of the cost of government, Tax Freedom Day divides all federal, state, and local taxes by the nation’s income. In 2013, Americans will pay $2.76 trillion in federal taxes and $1.45 trillion in state taxes, for a total tax bill of $4.22 trillion, or 29.4 percent of income. April 18 is 29.4 percent, or 108 days, into the year." The Tax Foundation http://taxfoundation.org/article/tax-freedom-day-2013-april-...

    "However, under our marginal tax system we pay 10 percent on the first $17,000, or $1,700. We then pay 15 percent on the next band of income up to $69,000, or $7,800. We then pay 25 percent on the marginal amount over $69,000, for another $12,750 in taxes. When we total the taxes paid on these three bands of income it comes to $22,250, for an average (or effective) tax rate of 18.5 percent.

    Of course, in our simplified example we have not taken account of all the exemptions, credits, and deductions that are available to us. These deductions reduce our taxable income. So instead of paying taxes on $120,000, the deductions for our children, mortgage, and charitable contributions could easily reduce our taxable income well below $90,000. At this taxable income we would owe a total of $14,750, for an average rate of about 12 percent." - The very same Tax Foundation - http://taxfoundation.org/blog/even-14-romney-pays-higher-rat...

    "Millionaires go through the same process, meaning they pay 10 percent on the first band of income, 15 percent on the next band, and so forth. As the chart below shows, based on the most recent IRS data for 2009, the average tax rate (after deductions) paid by all Americans is 11 percent. It is also clear that millionaires pay an average of 25 percent, while virtually every taxpayer earning under $100,000 pays an average rate of no more than 8 percent of their income in taxes. [Click here for more detail on the chart's data.)

    There are roughly 123 million taxpayers who earn under $100,000, or about 88 percent of the 140 million Americans who filed a tax return in 2009. In other words, 88 percent of all taxpayers pay 8 percent or less of their income in income taxes.

    Which gets us back to Mitt Romney's effective tax rate of 14 percent, after deductions. As the chart shows, this rate is still higher than the average rate paid by taxpayers earning up to $200,000. There are about 136 million taxpayers who have adjusted gross incomes less than $200,000, or 97 percent of all taxpayers. So even with an average tax rate of 14 percent, Romney paid a higher average rate than 97 percent of his fellow Americans." - Still the very same Tax Foundation http://taxfoundation.org/blog/even-14-romney-pays-higher-rat...

    So, according to the Tax Foundation, Mitt Romney achieved Federal Tax Freedom day on February 20th, at 2:00 am. They say I had achieved Federal Tax Freedom day even before then.

    In fact the non-partisan "The rich pay a higher rate than you do" article I linked to says the average Federal tax rate for the bottom 97% of Americans is 11%, and so those 97% worked until February 9th for their highways and stuff.

    Of course in the non-partisan Tax Freedom day article you referenced it says that federal social insurance taxes plus income taxes take 56 days to pay which is February 25th or a Federal Tax rate of 15.5%, so now they are telling me that I am paying a higher percentage than the percentage they told me Romney pays (14%) in the article they told me Romney pays a higher percentage than I do.

    Maybe this Tax foundation group js a little politically picky-choosey about what they include when they write they write.

    Best wishes,

    Steven

  • Report this Comment On April 20, 2013, at 8:22 AM, devoish wrote:

    Did you read this article by Morgan Housel?

    "Admit It: No one has any idea what is going on"

    http://www.fool.com/investing/general/2013/04/18/admit-it-no...

    Do you think the problem is most American are working so many hours they have no time to check the integrity of the facts behind the conclusions of what "think tanks" are paid to write?

    Do you think the problem is that most "think tanks" articles are repeated endlessly by authors who have not really thought about the claims the think tanks are making in the context of the claims the same think tanks have already made?

    In 1968 minimum wage was $1.60 an hour. If it had grown as fast as reported income it would be $22.00/ hour today and SSI and Medicare would be in the black.

    Today an engineer pays for college and gets a lower percentage of US income than a minimum wage worker did in 1968.

    "If we started in 1960 and we said that as productivity goes up, that is as workers are producing more, then the minimum wage is going to go up the same. And if that were the case then the minimum wage today would be about $22 an hour," she said, speaking to Dr. Arindrajit Dube, a University of Massachusetts Amherst professor who has studied the economic impacts of minimum wage. "So my question is Mr. Dube, with a minimum wage of $7.25 an hour, what happened to the other $14.75? It sure didn't go to the worker."

    Dube went on to note that if minimum wage incomes had grown over that period at the same pace as it had for the top 1 percent of income earners, the minimum wage would actually be closer to $33 an hour than the current $7.25."

    http://www.huffingtonpost.com/2013/03/18/elizabeth-warren-mi...

    Because is goes to investors instead of employees none of it supports SSI or medicare for the employees who produced it, we have to work untill we are older instead of retiring younger,

    Plus, the extra 5% in taxes ($1800) on earnings above $8900 dollars that more than half of single filer American employees would have to pay, and the extra 5% joint filers would have to pay on their increased incomes ($3625) would probably make the federal gov solvent in a decade or so.

    Plus, Tax Freedom day would come much sooner!

    Best wishes,

    Steven

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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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