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Capital gains are the profits acquired from the sale of property or an investment and they are taxed at a different rate than that of typical income bracket rates. If you held this investment or property for longer than a year it’s taxed at 15%.
That’s the same rate you pay if you are living under the poverty threshhold, and it is staggeringly low. As long as you have the money to buy these investments or properties there isn’t very much work to be done. You might have to do a bit of research but property tends to appreciate at a higher rate than inflation and you can always invest in a hedge fund that does all the research for you.
Just as an example: I made $60.00 today from my job, I made $105.50 from having $11,000 in my brokerage account. To make the $60.00 I had to go to school to get the proper credentials and then I had to go to work and provide a service which took using my brain, skills, and most valuable of all my time. To make the $105.50 all I had to do was transfer money from one place to another by pressing a couple keys on my laptop (I did that weeks ago so it’s not even a daily process). By going to school and working hard I gained $60.00; by doing nothing I gained $105.50 – and to boot, the larger sum of money is getting taxed at less than half the rate of the smaller sum (when factoring in self employment tax which is 15% but I’ll get to that in a minute.)
Anyone who’s worked as an independent contractor knows that it comes with a lot of unpaid work and risk. For one, you are not eligible for workers’ compensation or unemployment. You must often find your own clients and work can be unstable. You’d think that this kind of entrepreneurship would be encouraged, but above and beyond paying the dues owed due to the tax bracket you fall into, as an independent, you must now face an additional 15% for going through the hassle. Remember the largest jump in the regular bracket system is 10% so working for yourself is like voluntarily jumping up two brackets without making the additional income.
People say that the benefit is all of the things you can write off, but realistically speaking that’s a lot less than you’d think and if you write off too much you can expect to be audited. Making sure that all the deductions are taken care of properly is just more uncompensated work. The real double-edge is that your employer is writing off all those things while providing you employment. Also, he is taxed less than you, as a gift for finding the logical path toward making you an indie contractor.
They write you off, as they would the purchase of a shovel, or the rental of a tractor. You on the other hand, assume both the human tax position, of both the employer, and the employee. Overtime is also taxed at a different rate than that of the typical annual income bracket. Let’s break down what happens in the case of overtime compensation. We can say someone is making $20.00 an hour and with time-and-a-half her overtime comes out to $30.00. However, roughly 28% will go to the state (depending on the state). She will pay an additional 6% as Federal payroll tax as well as 6% income tax. Her employer will be subject to a 7.65% payroll tax on her behalf.
The lowest you could end up paying for overtime is 40% which is higher than even the top-tier annual income bracket. So, in a country that pretends to reward hard work what we find is the exact opposite. If you have the money to invest in property, mutual funds, stocks, etc, your tax burden is astronomically reduced compared to that of an equally-abled person who directly puts in the sweat and blood needed to face greater hours, or to work for themselves.
To be continued…
Joey, your overall theme that the IRC favors investment income such as long term capital gains or qualified dividends compared to earned income such as wages is loud and clear…and it is true. The tax code definitely provides tax breaks for certain types of income. There are many areas that the tax code favors one over another…retirement savers, parents with children, education savers, charity donors, homeowners, etc…
However, when you get into the details, I start to shake my head as I think you are providing some misinformation at worst and lack of full necessary information at best, likely not on purpose but still misinformation. I will try to tackle some them in order of your article…
15% Tax Rate- The long term capital gain and qualified dividend (LTCG/QD) rate has a sliding tax scale depending on income levels and year. It is much more complicated than just 15%. The max rate for high income earners in 2013 will actually be 23.8% due to the new 20% rate plus the 3.8% Medicare Surcharge. Those who are in the 15% or under tax brackets (i.e. Married Couple with taxable income of <$72K) will ordinarily have zero tax on their LTCG/QD income…this is a HUGE benefit for a some, especially seniors. For comparison, to the "rich" it is now more appropriate to compare the 2013 all in federal rate of 23.8%.
"That's the same rate you pay if you are living under the poverty threshold…"- Presumably, you are indicating that someone who is making poverty level income is being taxed the same as someone who receives capital gains rates. This simply is not true. For a single person, the 2013 poverty level is at $11,490 (we will use $12K) to make it easy. Someone who earns wages of $12K per year will not pay any income tax. In fact, they very well may get the earned income tax credit (EITC) and therefore have a negative tax rate. For a family of 4, the level is approx $24K and they will still not pay any federal income tax and will get a very good sized EITC. To compare appropriately, we should add in payroll taxes though…this will add approximately 7.65% for federal purposes (CA has SDI rate which is approx 1% also), so someone earning at poverty level would have an all in federal tax rate of about 8% before considering the earned income tax credit which would likely bring their true rate down to lower (sometimes even negative in the case of the family of 4 earning $24K). If they are self-employed, they will pay both side of the SocSec/Med but it will still be less than the 23.8% for the high income earners in 2013. I am not saying that the income that those who earn at the poverty rates are enough to live on or anything, but your premise that the referenced tax rate is the same as those who make poverty level income is simply not true.
"To make the $105.50 all I had to do was…"- No, that is not all you had to do. You first had to earn the $11K (or whatever you initially put in) to make the $105. That $11K was taxed when earned initially. Oh and don't forget the tax benefits that are provided for that education that were available to in order to make that $60. However, again the Tax Code does favor investing compared to earning…no arguing there, that is just a fact.
"You are not eligible for worker's comp…"- I am pretty sure that you can purchase a workers' compensation policy even when you are self-employed. If not a true worker's comp policy a similar policy under a separate name. Employers get this for their employees, so if a business owner wants to purchase an owner's policy, I am pretty sure it is available…obviously, this should be priced into what is charged to your customer/client.
"…you must now face an additional 15% for going through the hassle."- Remember, half of that 15% you would pay if you were an employee so you not facing an additional 15% but instead an additional 7.5%. In fact, you get to deduct about half of the 15%, so your true incremental self-employment tax is a tad lower. This is the portion that an employee's employer pays on behalf of their employee…you are now your own employer so you pay both sides of it. Hopefully your pricing structure takes this into account with your client/customer.
"…the things you can write off…that's a lot less than you'd think…"- For most self-employed, the ability to write off their legit business expenses is a huge benefit and often will more than make up for the additional 7.5% or so of the self-employment tax.
"Making sure that all the deductions are taken care of properly is just more uncompensated work."- This is part of being a business owner…you have to take care of your books, licenses, billing, paying bills, regulations, insurance, etc…It should not be "uncompensated work" though as it should be included in the amount you bill to your client/customer.
"Overtime is also taxed at a different rate than that of the typical annual income bracket"- OT for an employee is taxed as ordinary income and therefore is taxed the same as regular non-OT wages. The OT will be subject to regular income tax plus SocSec/Medicare Tax (payroll taxes). It does NOT change because it is OT. Sure, the OT is included in overall taxable income so depending on the overall income, it may be taxed at a higher % but that is the same as if you got a raise. This is our marginal tax system. The reason why it may seem like the tax bite is big is because exemptions and standard deductions are getting diluted with each dollar earned.
"The lowest you could end up paying for overtime is 40% which is higher than even the top-tier annual income bracket."- Ugh, this is frustrating the misinformation I just have to blame on a complicated tax code which I make a living off of. There are so many variables that go into this, but rest assure the lower you could end up paying for overtime is not 40%…it certainly could be the same as non-OT wage income earned. It could be in some cases 40% but it certainly is not the lowest it could be.
By the way, nothing in this or any of my other posts/comments constitutes professional advice or guidance….seek your own competent tax advice from an advisor who is aware of your individual situation.