History of US Taxes

Here’s an interesting infographic regarding the history of US taxes.

President Lincoln enacted the first taxes in 1862 to pay for the civil war. The lowest tax bracket was 3%, while the highest was 5%. It was later repealed in 1872 until 1894 when it reintroduced again.

In 1913, the highest tax bracket was 7%.

In 1945, the highest tax bracket was a whopping 94%. Why do politicians love other peoples money?

Click on the graphic to make it larger.
History of US Taxes - Infographic

Interesting Libertarian Rant Of The Week

This is an interesting rant on the equality of paying taxes by newsletter editor Porter Stansberry:

According to the federales themselves, the top 1% of wage earners in the United States earned more than $388,806 in 2006.

There were 1.65 million citizens in this category. As a group, they paid $488 billion in income taxes. That was 40% of all income taxes. But they only earned 22% of all wages. In short, the marginal tax rates on America’s top earners were almost 100% more than average. OBAMA! will increase the top rate these people pay – because paying 100% more than average just isn’t quite “fair” enough.

We might argue about whether or not we ought to charge some citizens different rates of income tax. But if you’ll take the time to read the U.S. Constitution, it’s clear that progressive taxation is unconstitutional. Just read the 14th Amendment. It says the government “may not deny to any person within its jurisdiction the equal protection of the laws.” That means the law can’t treat one citizen differently from another – white or black, rich or poor.

If our Constitution weren’t merely a dead letter, the equal protection clause – which was designed to prevent black people from being discriminated against by southern states following the Civil War – would now effectively prevent a black president from “spreading the wealth around” as much as he sees fit. History is nothing if not ironic.

Even if you think progressive taxation is a good idea and redistributing income ought to be the government’s prerogative, I can tell you judging from history and the recent experiences of several different countries, when society expects 40% of the tax burden to be carried by only 1% of the population, bad things happen. The masses always demand too many services from the government – because they’re not paying for them. And, eventually, the 1% that’s paying leaves, quits working, or hides their income.

The result is always catastrophic, not only for the state but for the culture. Once people get used to living off the bounty of their neighbors, they’re reluctant to go back to work. And they’re angry about it. There’s not much more dangerous to society than lots of poor, angry, and desperate people who have become addicted to entitlements. Think unionized employees at Chrysler and GM. Welcome to Amerika.

At the present time, America’s income taxes are the most progressive of any major industrialized nation. That’s not a contest we should seek to win.

A lot of so called tax-reforms are anything but. Consider the introduction of the refundable tax credits, which looks like it will push America to follow Europe down the road of socialism!

The sad fact is that America is broke and the money required to pay interest on the money we’ve borrowed has to come from somewhere? Should we continue to “soak the rich”, or should everyone buckle-up and contribute their fair share? Or maybe we should just continue with business as usual and let our kids and grandkids deal with the consequences?

Why The “Cash For Clunkers” Idea Is Stupid

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In case you haven’t heard, Congress will soon implement a “Cash For Clunkers” program. If you trade in your old car, you’ll get $3,500 towards the lease or purchase of a new one. If you have an old SUV you’ll get $4,500. Seems like a good plan doesn’t it?

Yesterday I had a short phone call with Bob Meigan, VP of TurboTax and we discussed the short-comings of this program. First of all, your car has to be a clunker. That is it shouldn’t be worth more than $3,500 since you won’t get anything extra if it is worth more.  By law, the dealer will have to scrap the car so even if its worth $5,000 he’s not going to give you a dime more than the $3,500 he’s getting from the goverment.

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So basically you need to be driving something like a  salvaged car that you’ll trade in for a brand new one. Secondly, the salvaged car needs to be getting 18 miles or less ( I think its 16 for the SUVs) according to the EPA sticker when you first bought it. 

Don’t you think that people who are driving around worthless junk with terrible gas mileage are doing it becauase they can’t afford a nicer car? Do you think a $3,500 incentive will enable them to afford a new car? The incentive is probaly worth only $70/month over a 5 year period on a car loan – I’m pretty sure you’ll need to come up with the rest.

And in order to prevent people from gaming the system and buying salvage car for a thousand dollars and using them to get a bigger discount, the plan enforces that you must have owned the car for a year. (And the promotion only runs from July to November 2009).

So probably the only people who will be able to use this program are students who were driving around clunkers and now having found jobs despite the tough economy are looking to upgrade. However, these people would’ve bought cars anyway, so there’s no real stimulus to the economy or the car companies. Just another waste of time and money.

However, if you are in the market for a new car, remember you can deduct the sales tax this year.

California Tax Refunds To Be Delayed

The state of California, the 9th largest economy in the world, is having liquidity issues of its own. Faced with a shortfall in taxes, it under-budgeted by nearly $42 billion. The government said it will have to delay issuing tax refunds. In fact, according to Governator Arnold Schwarzenegger, the state could run out of cash by February.

According to the AP News:

California’s controller says he will begin a 30-day delay on tax refunds and other payments starting Feb. 1 because the state is running out of money.

Controller John Chiang said Friday he must delay $3.7 billion in payments next month because lawmakers have failed to address California’s growing deficit.

With a $41.6 billion shortfall over the next year-and-a-half, the state is on the brink of issuing IOUs.

Chiang says his office must continue education and debt payments but will defer money for tax refunds, student aid, social services and mental health programs.

A severe drop in revenue has left the state’s main bank account depleted. The state had been relying on borrowing from special funds and Wall Street investors; those options are no longer available.

Tax Breaks For New Home Buyers

According to The American Housing Rescue and Foreclosure Prevention Act of 2008, passed by Congress in July, first time home buyers who purchase homes between April 8th 2008 and July 1st 2009 are eligible for a first time home buyer tax credit. They can get $7,500 tax credit or up to 10% of the value of the home for home purchases under $75,000.

There are certain conditions though. The credit has to be repaid over 15 years, so effectively it’s an interest-free loan from the government. So if you buy a home this year and claim the credit next year, you start paying $500 back in your 2010 taxes which you would file in 2011. So at least you get a few years grace period before you have to start paying it back. Not sure what happens if you sell the home in 2010, though. Maybe you might have to pay back the entire amount in a lump sum.

There are also income exemptions. The credit is phased out for individuals with modified adjusted gross income (AGI) between $75,000 and $95,000. For married couples filing a joint return, the phase out range is $150,000 to $170,000.

But the good news is that if you haven’t owned a primary residence for 3 years by the date of closing, you’re now considered a first time home buyer again!

This is the government’s way to encourage home purchases and prop up housing for as long as possible. This is their “soft landing” approach, where by they try to drag out this mess for as long as possible. Instead of having a quick easy death for banks and mortgage companies, they’re going to keep interfering and prolong the recession.

Regardless of the motives behind it, its out there for home buyers. I’m not jumping to buy at this point since I think there’s probably a little more downside next year followed by several years of stagnation.

Foreclosures have hit record highs and there are seemingly good deals all over the nation. My condo is currently in foreclosure and several of my friends have expressed an interest in buying it as an investment. I’ve told all of them to wait until they can actually cash-flow on investment property. Unlike back in 2005, where it was common to be negative several hundred dollars on an investment property, today you should be able to get 6% or better cash-on-cash return. In fact, in some places you can actually buy properties for under $5,000 and your effective return might easily cross 25% per year.

Before you rush out and start buying any property, I suggest you read the following books:

Tax Benefits Of Passive Income

Since this is tax season and this site is dedicated to earning passive income, I thought I should post something about the taxation of passive income. From the IRS’s point of view passive income is any income that you get without having to to materially participate in. Examples of passive income include rental properties and partnership returns.

Unlike earned income, passive income has great tax benefits. Earned income is subject to self-employment tax which is just over 15.5% (if you’re W2 employee, your employer pays half of this). Your passive income isn’t subject to this tax. If you own rental property, you also claim depreciation. Depreciation is the replacement cost of equipment used in a business and is spread out over its useful life. For residential real estate, the IRS deems the useful life to be 27.5 years. However, the useful life of a house could well exceed 60 years. This results in you being able to claim a tax loss which doesn’t really result in any loss to you. Because of this, depreciation losses are sometimes termed as phantom losses.

Let me give an example. Suppose you buy a rental property for $325,000. The tax bill says the land is worth $50,000 and the improvements (everything else thats built on the land) are worth the remaining $275,000. Based on the IRS’s straight-line depreciation method of deducting the cost of the improvements over 27.5 years, you get to claim $10,000 a year in depreciation. Assuming you have a mortgage of $275,000 at 5%, you’ll pay about $13,750 in mortgage interest payments. Assuming the property tax rate is 1.5% (its about 1.25% in California, 0.07% in Utah, 3% in Texas and a whopping 6% in New York) and the insurance and miscellaneous expenses are another 0.5%, you’ll be paying another $6000/year. In all you have actual expenses worth 19,750 per year plus depreciation loss of $10,000 bringing your grand total to $29,750. If you’re getting $1750 per month in rent, that works out to $21,000 worth of rental income. Since your actual costs are $19,750, you’re making a profit of $1,250. However, according to IRS passive income rules, you’re technically making a $8,750 loss!

Not only do you not pay taxes on your $1,250 worth of rental income, but you also get to deduct the $8,750 phantom loss from your regular earned income! In a 30% tax bracket, thats a $3,000 tax saving! You can deduct upto $25,000 worth of passive income losses on your taxes every year! If you have more losses, you can carry these forward until you can offset them against passive gains (like the sale of the property).

The flip side to this rule is the depreciation recapture rule which means you need to add back in the depreciation losses when you sell the property. However, this can be somewhat avoided by the use of a 1031 exchange (also called a Starker exchange).

Note that there are many nuances to this grossly simplified example so please don’t flame me, especially if you’re a qualified tax professional.

Qualified stock dividends are also another form of passive income that attract favorable tax rates. Instead of being taxed as ordinary income, the maximum tax rate is now 15% for most people. In fact, if your tax rate is 10% or less, you’ll pay only 5% income tax on your qualified dividends! There are certain restrictions that come with these lower taxations. The corporation issuing the dividends must be a domestic US corporation or a qualified foreign company. There is also a holding period of 60 day before the ex-dividend date and 59 days after the ex-dividend date.

What I term as passive income from my websites does not necessarily match the IRS’s definition of passive income. It is ordinary income and is thus subject to ordinary income tax. So I channel that income through a corporation. This is a form of income splitting. By creating a separate tax entity, I reduce the effective tax burden. I use that corporation to pay necessary and customary expenses required for the generation of this income, like my internet & phone service, computer equipment, investment newsletters, etc. Whatever is left after expenses, is taxable income. For US corporations that make $50,000 or less in profit, the tax rate is 15%. There is also question of double taxation for corporations (both the corporation and the shareholders have to pay taxes on the income that is distributed), but for now that doesn’t affect me. I’ll worry about it when it becomes an issue.

The income I get from direct oil well drilling programs is also taxable but it comes with depletion credits. As a result, 15% of the income is tax-free.

The IRS definitely gives a lot of tax benefits to passively earned income. If you have to work for your income and get paid as a W2 employee, you have the least number of tax breaks and will usually pay the highest taxes. Creating passive income streams is not only a better alternative to working, but you even get favorable tax treatment. If you’re looking for ways to generate passive income, make sure you read all the passive income posts. and check out my investment store.

Note: I am not a tax professional, nor do I play on on TV! Please consult your tax adviser before you make any financial decisions. If you’re subject to exemption phase-outs or AMT this advice may not apply to you.

Gimme My $1.395 Million Back!

I know for a fact that I’m not going to get my share of Social Security and I don’t even have a choice whether I want to contribute or not.  But how much will my share be?

Lets assuming the average person makes $50,000 a year for 35 years. Even though most people start working with they’re 16 and keep working until they’re 65, we’ll exclude the first 14 years when they may not be making a lot. We’ll also ignore the effects of inflation and salary increases to keep the math simple.

Considering that Social Security taxes (FICA and Medicaid) are ~15%, (even if you’re an employee andd only pay half of that, its a cost to your company that results in a lower salary to you) that comes out to $7,500 per year.  Considering the savings could have been invested in the stock market at 8%, the total comes to a whopping $1,395,766.11.

But the Government doesn’t have enough to pay out the baby boomers through the end of the next decade. So I’m sure I’m not going to get of my Social Security checks in 30+ years.

I think the government should privatize Social Security and create individual accounts for everyone. Or atleast stop taxing me and let me figure out my own retirement!

To see the opinions of various  presidential candiates regarding Social Security, check out this link. And please vote for Ron Paul if you’d like the president to be someone who realizes that we’re bankrupt and the monetary system needs to be fixed.

Gouging At The Pump?

Isn’t it funny how the ruckus about high gasoline prices has disappeared? I no longer hear anything about it on the news, the politicians haven’t taxed Exxon-Mobile’s record profits, and I don’t get idiotic emails asking me to boycott gas stations for one day in a year.

Yesterday I was filling gas and I decided to actually calculate how much tax I pay on each gallon. Regular was $2.99 of which about 7.75% is sales tax, but there were a few other taxes added. All told, $0.92 was taxes, which works out to about 30% taxes on each gallon.

Sounds like the government is already getting the lion’s share of profits and they didn’t want anyone else to get in on the action!

Since I hate paying any form of taxes, I think I’m finally motivated to reduce my driving to cut down on my gas usage!

Taxes Suck! (And so does Aurora Loan Services)

I hate taxes. And I hate filing them

For one I feel the government doesn’t know how to properly utilize the money it gets. Unlike Australia, where the budget is in a state of constant surplus, our illiterate politicians can’t add and are always running a deficit. And as a result, they always begging for more money.

Another issue is with the reporting of taxes due. As the owner of several rental properties, I get to claim the interest on the mortgage payments and the taxes I pay. The mortgage companies send out a 1098 form every year. Unfortunately they do 3 things that piss me off.

1. They keep selling the mortgages to other companies.
This means I not only have to keep track of the payments(which I automate through online bill pay), but now I get several 1098s for the same property.

2. They don’t print addresses on the 1098 statements.
This means I have no fricking clue which property the statement belongs to and I have to waste time matching up the statements with the properties based on 9 digit account numbers. (really irritating when you have 6 times as many statements as you do properties!)

3. They make stupid mistakes.
Occasionally, they’ll forget to include the amount of taxes paid or insurance paid. If you overlook that, you’re out that deduction. Yes, it looks like you made more money but thats a BAD thing at tax time!

If my Adjusted Gross Income[thats income after deductions) isnt’ under the federal guidelines for the poverty level, I’m pretty upset. And now the wife had to go get a job which totally pushed us out of the poverty level! I told her if our tax bracket went too high, I’d quit my job in protest! (Of course, that didn’t go down too well).

And whats up with the schedule D filling. The government wants me to file every single damn trade I placed??? Well ok, they don’t trust us to accurately report it, whcih is fine since we don’t trust the government to tell us the truth either. But why the hell can’t the brokerage firms provide a simple spreadsheet of the transactions? (without charging for it?). Its all computer-based trading and they all have the records in their databases.

I actually found out that Interactive Brokers (the company with the worst interface and lousiest customer service, but cheapest commissions) actually provides a prepared schedule D!!! Thats awfully nice of them.

Especially since Datek, Ameritrade, TDAmeritrade charges 10 times the commission and won’t provide it. Infact they got the 1099 wrong the first 3 times!

Anyway, I was up until 4:30 am doing my taxes. One of the mortgage companies fraudulently decided that my 5 year ARM was a 2 year ARM just because the date printed on the loan docs was wrong. The fact that they never offered a 2/1 ARM doesn’t matter. Aurora Loans got to screw me and the truth can be damned! Anyway, my new rate is now 10.3% on the 1st loan, and 9.5% on the 2nd loan!

Aurora also wanted nearly $10,000 to refinance a $250,000 loan! I went to Countrywide instead but they need to see my 2006 tax returns to fund the loan. Hence the rush to get the paperwork all done so my CPA can file it.

Anyway, thats it for this friday’s edition of The Weekly Rant!

Tax Time Again

Its that time of year where I really need to file my tax return and get my $2,000 out of the IRS. I really hate doing my taxes and I usually file an extension and postpone it until the very last moment. This year my wife suggested a novel idea. Have my CPA do them! I normally do them myself, but last year I found a competent CPA and had him look over them after I had already done them. He said they were fine and didn’t need any changes, so I had him sign and send them in. According to Perfectly Legal, this reduces your chance of an audit.

I really hadn’t thought of just giving him all the stuff and having him do the taxes. Its probably my deep-rooted belief that no one cares for your money like you do. My CPA’s very competent and probably does several hundred tax returns a year, so his knowledge is better than mine and he’ll probably do them quicker as well.

Incidentally, he set me up with a 401k pension plan combo for my corporation, of which I’m the trustee! So technically I can invest in any damn investment I please and its all tax deferred!

Of course, theres a lot of discussion about investing in 401ks and avoiding the capital gains tax but being stuck with income tax when you withdraw [income tax is higher than capital gains, hence the discussion]. While that true, everytime you realise a gain on an investment, you need to pay tax[unless you defer it using a 1031 or some other method]. This could be as often as every year! This way atleast I don’t have to worry about taxes for 30+ years!

Of course a better way would be to use a self-directed ROTH IRA. I’m currently researching how to set one up and I’ll post my findings soon.

A really good book on tax deductions is 422 Tax Deductions for Businesse. Its a very easy read.

Another good book I read over the weekend is Missed Fortune: Dispel the Money Myth-Conceptions–Isn’t It Time You Became Wealthy?. I only read the half the book on not paying off your home and leveraging it into better investments. I didn’t read the part on insurance but its a pretty interesting book nonetheless.