In the past I wrote about Warren Buffet's outrageous statement, that he paid a lower tax rate than his secretary. I look into it more deeply here. To set this up, we need to understand marginal tax rates, a subject many folks don't comprehend at all. Many, many people believe if they make a higher income, and get pushed into a higher tax bracket, that all their income is taxed at the higher rate. Not so. Here is how it works for Federal Income Tax:
- Only your Taxable Income (TI) is taxed, after subtracting Exemptions and a few other items such as Itemized Deductions or the Standard Deduction from Adjusted Gross Income (AGI).
- Your first dollar of TI is taxed at the lowest bracket rate, which is 10% for 2012, no matter how much you make.
- If you are Married Filing Jointly, for example, the first $17,400 is taxed at this 10% rate.
- A couple whose TI is $17,401 is taxed at the next rate (15% in 2012) only on that last dollar. A married couple has to have a TI of $70,700 to reach the next bracket (25%).
- There are six brackets. The top bracket, currently starting at TI of $388,350, is 35%. By the way, the "one percent" earn $380,000 or more, so this bracket is for the one percenters. But their first $388,350 of TI is taxed at all five lower rates, which averages out to 27% for that money. From dollar 388,351 and up, the tax is 35%.
There are two kinds of dividends. Qualified Dividends are taxed at 15%. Ordinary Dividends are taxed at the rate corresponding to your tax bracket, and dividends are used in calculating AGI and TI. So Buffet is taxed between 15% and 35% on his TI, depending on the proportion of Qualified Dividends in his portfolio. You'll have to look up what QD's are versus OD's; we won't go into that here.
Now let's look into this more deeply. I used the Tax Estimator at HR Block to examine five scenarios:
- An entry-level Clerk at the Snarfle Corp. named Philip Elton. He is single, earns $36,000, uses the Standard Deduction, and ignores the company's 401K, in spite of the matching provision.
- An Administrative Assistant at Snarfle named Anne Weston. She is 60 and widowed, with a dependent son still at home. She earns $60,000—at the high end for "secretaries", so she may resemble Buffet's secretary—and puts 3% into the 401K to get the company match. She rents and gives a little to charity, but uses the Standard Deduction. She files as Head of Household.
- A Manager, Anne's boss, 45-year-old Charles Bingley earns a $120,000 salary and $10,000 in ordinary dividends. He puts 15% into the 401K, owns a home, and deducts $12,000 in mortgage interest, $4,000 in property taxes, and $10,000 in charitable giving. He is divorced, and there were no children, so he files as Single. His wife is a lawyer and makes more than he, so he avoided paying alimony by suing her for alimony, then settling for "no fault, no foul" terms with no money changing hands.
- The Snarfle Corp. CEO, Emma Woodhouse, is 60 and married. Her husband is retired. There are no dependents. Her salary is $12 million. Their total income is $13.5 million, including $500,000 in QD's. She puts $23,000 into the 401K, another $5,000 into an IRA. The couple deducts $48,000 for mortgage interest, $15,000 in property taxes, and $50,000 in charitable giving.
- John Willoughby, 60, is a major stockholder in Snarfle and a few other companies. His primary income is from dividends, $12 million. Half of that is QD's. He takes a "salary" of $1 from another company as an executive "emeritus". He is married. His wife has never worked. There are no dependents. He uses annuities to defer taxes on $100,000 of income yearly, deducts $150,000 in mortgage interest, $30,000 in property taxes, and $500,000 in charitable giving.
- Philip Elton pays $3,503 in Federal Income Tax (FIT) on TI of $26,250. The tax is 13.3% of TI and 9.7% of Gross Income (GI).
- Anne Weston pays $5,665 in FIT on TI of $41,900. She is in the 15% bracket. The tax is 13.5% of TI and 9.4% of GI.
- Charles Bingley pays $16,580 in FIT on TI of $82,200. He is in the 25% bracket. The tax is 20.1% of TI and 12.8% of GI.
- Emma Woodhouse pays $4,404,850 on TI of $12,851,400. She is in the top bracket, being a one percenter; the tax is 34.3% of TI and 32.6% of GI.
- The plutocrat John Willoughby pays $1,981,450 on TI of $7,212,401. The tax is 27.5% of TI and 16.5% of GI.
I must conclude that Mr. Buffet's statement was entirely false, and further, that he is either a liar or a fool.
P.S. This post is my 1700th.