Less Rich. Less Famous. Less Tax.

7/5/2012

Last week, we brought you a story from the IRS Statistics of Income Division about an annual report on the 400 highest incomes in America. It turns out they’re a very successful bunch – for 2009, they earned an average of $202.4 million and paid an average of $40.9 million in tax. This week, we’re going to talk about a different group of taxpayers. Less rich and famous, but maybe more successful in their own way.
 

Back in 1969, Treasury Secretary Joseph Barr was shocked to discover that 155 Americans had earned over $200,000 that year, yet paid nothing in tax. ($200,000 isn’t bad money now – back then, it had about the same buying power as $1.2 million today.) Washington then passed the “Alternative Minimum Tax,” or AMT to make sure all Americans paid their fair share. In 1970, the new tax surprised 18,464 unhappy taxpayers. No one could have foreseen it growing into a complete “parallel” tax system that currently affects millions of middle class taxpayers every year.
 

Fast-forward to today. With the AMT firmly in place, the IRS has just released a 61-page report revealing that in 2009, 20,752 taxpayers earned over $200,000 and paid zero tax. That's one out of every 189 Americans earning above that amount. And the number of nontaxable high-income returns is growing fast – five years earlier, there were just 2,833 tax-free winners.
 

How do they do it? The IRS identified four categories that “most frequently had the largest effect in reducing taxes”:
 

  1. Tax–exempt interest: Municipal bond interest income is exempt from federal and most state income taxes (although income from “private activity” bonds is subject to AMT).
  2. Medical and dental expenses: These are deductible to the extent they top 7.5% of your adjusted gross income (going up to 10% next year, unless the Supreme Court strikes down that part of the Affordable Care Act). Medical deductions include far more than just the obvious doctors, dentists, and prescriptions. If you suffer from arthritis, for example, you might write off the cost of a swimming pool your doctor prescribes to relieve your symptoms.
  3. Charitable contributions: Charitable gifts let you do well for yourself while you do well for others. They’re deductible up to 50% of your adjusted gross income.
  4. Partnership and S corporation net losses: “Pass–through” entities let you report business losses on your personal return.

There you have it. Four ways to turn $200,000 into zero tax – and 20,752 stories to help inspire you. If you do have a lot of these deductions, it’s imperative that you keep detailed records and save all your documents in case the IRS decides to take a peek!