Halloween has come and gone, but I'd bet that I can scare the heebie-jeebies out of a vast majority of you by uttering one word.
Up to the challenge? Think you can handle it? Because here it comes ...
OK, fright may not be so much the word as anger, frustration, or the sudden urge to pull your hair out mixed with an overwhelming need to scream profusely at the governmental agency that's taxing you.
Taxes are what we might refer to as a necessary evil. Taxes help fund many branches of our government, which in turn provide for federal jobs, health and financial security for retirees in the form of Social Security and Medicare, and social funding for schools, prisons, clinical research projects, our national defense, and a vast number of other social projects.
While we know deep down that we need taxes to fund the aforementioned projects, we would seemingly do everything in our power to avoid paying them. Why? Put plainly, taxes aren't fun to pay, and the number of taxes we face only seems to be growing. There's federal tax, state income tax, local sales tax, property tax, inheritance tax, Social Security tax, Medicare tax, excise taxes, taxes on your cable and Internet, tax on gas purchases, tax on most utilities, local tolls to cross bridges and highways, and a myriad of licenses, registrations, and permits that may need to be paid for. I'm sure I'm forgetting some, but that's an awful lot of ways to potentially be taxed.
That's why today I want to dig a bit deeper into this necessary evil known as taxes by utilizing decades of research (link opens a PDF file) compiled by the American Enterprise Institute and polled by Gallup, CNN, USA Today and/or the Advisory Commission on Intergovernmental Relations so we can establish once and for all what America's five most hated taxes are. Not only will we get a glimpse into which taxes are believed to be the least fair, but I'll also add a few ideas you may be able to apply to potentially lower your own taxes this year and moving forward.
The fifth most hated tax: State income tax (7%)
Last year, according to the National Association of State Budget Officers, the 50 states plus the District of Colombia spent upwards of 1 trillion tax dollars. For many states, financing these expenditures, which have been shown to mostly go toward funding education and health care programs such as Medicaid, means implementing a state income tax.
The reason 7% of Americans chose paying state income tax as the least fair tax is probably because those respondents in the poll already felt that paying money to the federal government should be enough. If you're required to pay a state income tax as well as a federal income tax, it can create a feeling of being double-taxed. It's even more painful (if you live in a state that has an income tax, that is) when you realize that there are seven states that have no income tax at all and an additional two states that only tax select income such as dividend and interest income. Keep in mind, though, that these states may make up for their lack of an income tax with higher taxation in other departments, so it may wind up being more of a wash in the end, as you'll see with our third most hated tax below.
Aside from living in one of these seven income tax-free states, there's not a lot you can do about escaping a state income tax. However, keep in mind that for tax filers who are able to itemize, they can utilize state income and local taxes to reduce their federal taxes. See? There's a bright side to everything!
The fourth most hated tax: Social Security (10%)
Coming in as the fourth least favorite tax with 10% of the votes is the Social Security tax.
It's not hard to understand why people dislike this tax so much, because the system, barring a major overhaul or tax hike, is going to run out of its ability to take care of all eligible members by 2033. Further complicating matters, since many of us don't realize the benefits of Social Security income until well into our 60s or later, the younger generation has a generally negative view on the future of Social Security, with many claiming that it's had no effect on their lives up until now. If people don't see a tangible benefit to a social program or tax, the opinion is often that they don't like it -- it's that simple.
Like state income taxes, you can't avoid paying Social Security taxes, but you can certainly lower your taxable liability in your retirement years by following a couple of simple steps.
One idea, should you have a Traditional IRA, is to convert it to a Roth IRA which will be free of taxation as long as you wait until after the age of 59 1/2 to begin taking distributions. This is important as income received from a Traditional IRA will be taxed as ordinary income when you take a distribution which could, in combination with your Social Security disbursement, significantly raise your tax liability.
Another idea here is to wait as long as possible before you begin taking your Social Security distribution. Not only does your distribution increase each year that you wait beginning after your retirement age, but if you rely on your retirement savings from a Traditional IRA to cover your expenses prior to your required distributions beginning at age 70 1/2, you could potentially lower your taxable income via that disbursement when you do begin collecting Social Security at age 70.
The third most hated tax: State sales tax (17%)
Living in Washington state, this is one that personally chaps my hide, since I pay a whopping 8.6% sales tax in my city (handily making up for Washington's lack of an income tax). Apparently 17% of people also agree that it's the least fair tax of them all.
One reason to dislike state sales tax is that it's a regressive tax, meaning it greatly affects those with low income and has a lessening effect on people the higher you go up the income ladder. In addition, state sales taxes vary wildly. Some states, like Oregon, boast absolutely no state sales tax, whereas Tennessee will set you back with a state tax rate of 9.44%. If you live in one of these states with a high sales-tax rate, making a large purchase or a number of large purchases can be quite painful on the pocketbook.
Although you can't avoid paying sales tax if you live in a state that charges sales tax, one factor to keep in mind is that you can itemize your sales tax paid during the course of the year and utilize those taxes as a deduction against your earnings on your federal income taxes. It's not a perfect dollar-for-dollar deduction, but it could help lower your federal income tax liability.
The second most hated tax: Federal income tax (20%)
Surprised this isn't the most hated tax in America? I admit that I was! At one time, according to Gallup's numerous polls, federal income taxes were America's most hated tax, but that hasn't been the case since 1988.
One reason I'd postulate for the lessening hatred of income taxes relative to our most hated tax has been the improved ease of use of tax preparation software provided by Intuit (NASDAQ:INTU) via TurboTax, H&R Block (NYSE:HRB) via H&R Block At-Home, and Blucora's (NASDAQ:BCOR) TaxAct. Intuit, H&R Block and Blucora have made it such that taxpayers need only to follow easy on-screen instructions to file their federal and state income taxes electronically.
However, federal income taxes are still extremely time-consuming, require us to reveal extremely personal information, and are constantly changing from year to year, which makes them the most hated tax by 20% of those polled by Gallup, CNN, and USA Today in 2005.
Unless you want to go to jail for tax evasion, I would certainly encourage you not to avoid paying your share of your federal income taxes. Although, there are some unique ways you can lower your taxable liability.
For one, contributing to a Traditional IRA (up to $5,500 in 2013) can allow you to deduct this amount against your annual earnings. In addition, as we've discussed above, itemizing your state income and sales taxes paid can potentially reduce your federal tax liability. Other ways you can reduce your federal taxable income include making charitable donations to qualified organizations and holding your stocks for the long-term to take advantage of the long-term 15% tax rate, to name a few.
America's most hated tax: Local property tax (42%)
By far, America's most hated tax is your local property tax! It's almost ironic that your home, perhaps the single greatest source of taxable deductions on your federal income taxes, is also the greatest source of dislike when it comes to taxes in general among the American public with 42% responding that they felt it was the least fair tax of all.
Perhaps the single greatest source of frustration again comes from the fact that property taxes are regressive and constantly changing, hurting lower-income individuals much more than upper-income earners. Also, for many homeowners, property taxes can also be their largest annual tax bill, easily surpassing sales tax and federal income tax in amount owed. Finally, property taxes also tend to be a lagging indicator, since your home's value can change rapidly, up or down, within a given year. Following the recession, many homeowners were left paying property taxes on home values that were considerably higher than current market values and took quite a bit of time to correct.
I'm not going to lie that it isn't a challenge to lower your property taxes, but it's not impossible, either. You can start by doubling-checking the value of your home with your local assessor to ensure you're paying the correct amount of property taxes on your home. If, for instance, you believe the value of your home has been grossly overstated or you notice other comparable homes nearby that are valued lower than yours you can appeal to have the assessed value of your home lowered.