So THIS is the 1%?!!!

Interesting article today in on the cnnfn.com website.

http://money.cnn.com/2012/06/05/pf/taxes/top-400-highest-income/index.htm?iid=HP_LN

So THIS is the 1%?!!!

Actually, it is the top 400 returns out of 140,000,000 individual tax returns filed in 2009.

The top 1% would still be about 1,400,000 returns – so you’re way, way beyond the top 1%.

That being said - I have two problems with this article: 1) it doesn't truly represent how the tax is computed for these individuals and 2) it seems to imply that the top 400 club doesn't change.  In the latter case, only 2 percent of the "club" has been in the club for even 10 of the last 17 years, and about 75% changes every year.

In the former case, let's look at the "definitions" of income more closely.

Looking at the underlying IRS data, the income making up the average of $202,000,000 is broken down as follows (keep in mind it won’t total $202,000,000 since not everybody on the list has each item of income):

Salary was (on average) $22,000,000

Interest income was $13,000,000

Dividend income was $26,000,000

Capital gains was $92,000,000

Business income was $10,000,000

S-Corporation/Partnership income was $83,000,000 (there were about 280 of them)

They also paid on average $16,000,000 to charitable contributions and $12,000,000 to other taxing authorities.

I always had a problem with the publication (or, shall we say “promotion”) of effective tax rates (yes, even you, Warren Buffett, and your secretary)….

The standard metric for measuring effective tax rate is federal income taxes paid divided by adjusted gross income (which is basically all income less some business deductions, alimony, 401k contributions, or lines 7 to 31 of a Form 1040).

Individuals aren’t “taxed” on adjusted gross income though – they are taxed on  taxable income, which is adjusted gross income less itemized deductions.

The formula is as follows:

Salaries, wages, interest, dividends, S-Corp income

Less: Certain deductions like alimony, capital losses, business losses

Equals: Adjusted Gross Income

Less: Itemized deductions (mortgage interest, taxes paid to state and local governments, charities)

Equals: Taxable income

The problem with the effective tax rate argument is that is ignores other “taxes” that these high AGI taxpayers pay – like state and local income taxes.  You could also make the argument that it also ignores charitable contributions, which is many cases reduces the need for federal and state funding to certain organizations and individuals (think United Way, for example).

So in addition to  the $40,000,000 in federal taxes each person paid on average, they also paid an additional $28,000,000 in taxes and charitable contributions – or a total of $68,000,000 on $200,000,000 of income, or 34%.

The other problem with publishing the effective tax rate is that it also ignores someone who is particularly generous with charities.  For example, suppose someone  made $100,000,000 last year in income and gave $50,000,000 away to a charity.  His AGI is $100,000,000, but his tax of 35% would be computed on income of only $50,000,000 – or $17,500,000.  His effective tax rate then is $17,500,000 divided by $100,000,000 or 17.5%.

You could read the headlines and say “person making $100 million per year only taxed at 17% rate!!!” –  and think that social security tax alone for a person making $10,000 is nearly half that.  Certainly, that is correct, but I don’t think many people truly understand what is going on here….