It’s tax time and if you’re like most Americans you’re either hoping for a refund or praying you don’t owe Uncle Sam money you already spent. Unfortunately, many single young professionals are in the latter group, my brothers included.
After doing some research, asking other young professionals, and talking with my father (who is a government auditor) I began to learn several key reasons why my brothers’ tax rate, and yours too, may be much higher than the average. Here’s what I discovered….
They make a lot of money. This first reason is self-explanatory. In order to pay a high amount in taxes you usually have to be earning a high income. While everyone’s definition of “high income” may vary, it’s safe to say that if you are a single young professional making at least 6 figures per year (in any city except San Francisco, LA, DC, or NYC) then you are probably doing pretty well for yourself. Our tax code is progressive, which means that the more money you make the higher percentage you pay in taxes. While this may be a huge drag for many people in the higher tax brackets, the government provides services and protections we all benefit from and we can’t expect those struggling to provide for their basic needs to fund it. Much of the burden falls on the high earners.
They earn most, if not all, of their income from their employer. Earned income, such as the salaries we get from our jobs, is taxed at a much higher rate than passive income or investment income. So, if you get all of your money from your job and have not started generating other revenue streams from various investments or business ventures then you will be taxed at a higher percentage. Some young professionals make a good portion of their income from commissions due to sales or may earn end-of-the-year bonuses from their job. If these bonuses or commissions come in the form of a separate check, they are taxed at an even higher rate (22% in 2018). This means that nearly a fourth of the extra money they earned went directly to the government in taxes. Whether it’s all “earned income” from salary or a combination of salary, bonuses, and commissions, the issue is that the type of income they receive is taxed at a high rate.
They are single. It is no secret that married people have lower tax rates than single people. Just look at the tax brackets and you’ll see that a married couple making the same amount of money as a single person will pay much less in taxes each year. Why? Well because back in the day it wasn’t as common for both adults in a marriage to be employed. Typically, only the male worked and the wife stayed home to raise the kids. Thus, the government gave a tax break when people got married because it assumed that there was only 1 person working and didn’t want to overtax that one person who had to also use part of his (or her) earnings to financially support the non-working spouse. Nowadays, it is much more common that both people in a marriage work, but that tax benefit is still in place. Many young professionals are single and have waited longer to get married, thus they end up paying a higher portion in taxes. (Of note, this rule is reversed for couples that make over $600,000 a year, but for most folks, married couples pay less in taxes than single people.)
They do not have kids. The government wants people to procreate. Having kids that grow up to be productive members of society benefits the country as a whole and solidifies our viability as a nation. But kids cost money. Those little humans have so many needs and require a plethora of resources that can be quite expensive. The government understands this fact and has various tax breaks in place for people who have kids as a way of saying “here’s a small token of our appreciation for taking care of the little people.” Parents get a tax credit for raising kids, additional reimbursements for childcare costs, and other tax deductions for educational expenses. This does not make up for how much parents spend since kids are quite expensive, but it does help. Many single young professionals don’t have kids, so they are ineligible for these credits and tax breaks.
They do not have any dependents. Along with receiving a tax credit for having kids, there are also tax deductions for taking care of other people. Anyone who takes care of someone who can not, or does not, care for themselves (such as a child, disabled person, non-working relative, or elderly parent) can file his or her taxes as “head-of-household” instead of “single” which makes them eligible for larger tax deductions that save them even more money. Now I’m not suggesting that young professionals become fiscally responsible for other people, but I am pointing out the noticeable difference in tax savings that come from changing one’s tax filing status from single to Head-of-Household.
They do not own a home. Many young professionals prefer to live in major cities. They like being close to their jobs and having the convenience of apartment-style living (i.e. free maintenance repairs, in-house gyms, the freedom to move to another place after the lease ends, etc.). As a result, they pay rent. The only bad thing about paying rent and living in an apartment is that they are ineligible for one of the largest deductions in the tax code: the mortgage interest deduction. Many people who own a home have a monthly mortgage payment (since they didn’t pay the full cost for the home up front). While a portion of this mortgage payment is used to pay off the amount they borrowed from the bank, another portion of this monthly payment goes towards “interest” (the fee that the bank charges for loaning you money for the home). The government wants people to purchase homes and have reliable housing so there is an incentive in the tax code that allows homeowners to deduct the portion of their monthly mortgage payment that is “interest” from their taxes. When you first buy a home the “interest” portion of the mortgage payment is a fairly large percentage, so the mortgage interest deduction adds up to a large amount in tax savings. Thus, while many single young professionals are paying rent, some of their counterparts have purchased a home. Even though the monthly payment for the person who lives in a home may be the same or slightly higher than the cost of rent, the person who lives in the home is able to deduct a large portion of their monthly payment from their taxes and could be saving tens of thousands of dollars each year.
They are not putting much money into retirement accounts. Although some jobs may not offer a 401K, the majority of salaried jobs have a retirement account in place for their employees. The advantage of these accounts is that many of them are “tax-deferred.” This means that when you contribute to retirement plans like a 401K, you aren’t taxed on the money you put into the account until years later. As a result, the more money you put into your retirement account now, the lower your tax rate will be when you file your taxes each year. Despite these tax savings, many single young professionals don’t put as much money into their 401Ks as they can. To be fair, it is usually because they prefer to have more money available to them during each pay period. They might have other uses for that money, want to prioritize paying off their student loans, or may simply desire to live a more affluent lifestyle. While these are all understandable reasons, the fact that they are not contributing more to their 401Ks raises their tax rates.
They do not have enough money coming in from investments. The profit you make from investments (whether it is investing the stock market, real estate, or various businesses) is taxed at a much lower rate than earned income from your job. Sometimes it can even be shielded from taxes entirely. If single young professionals really want to lower how much they pay in taxes, they may need to invest the money they have in ways that can decrease their tax rates and add to their monthly incomes.
Despite all of these reasons for a high tax rate, my solution isn’t necessarily to get married, start having kids, or quickly buy a home or condo. While those are all viable things to do, I don’t advise that anyone rush into a decision like that. Making a decision in haste could have endless repercussions that could far outweigh the tax savings.
Instead, single young professionals should start actively investing more of their money. I am not suggesting that they randomly buy some stocks they saw on Bloomberg, or start investing in things they barely understand (like Bitcoin). Single young professionals should strongly consider starting a side business or begin investing in things like commodities or real estate. They will have to increase their knowledge on whichever route they choose so that they make educated investment decisions. Nevertheless, becoming an active investor or business owner will not only lower their tax rate, but it will also increase their monthly revenue and make them less dependent on the salaried jobs that keep taxing them at high rates.
To summarize, many single young professionals pay a lot of money in taxes. While each person’s situation may differ, there are usually 8 main reasons their tax rate is so high. They make a high income, they get most of their money from their jobs, and don’t actively invest a significant portion of their income. They also are single (and forgo the tax benefits of being married), many don’t have kids or dependents (which may save them money overall, but still make them ineligible for the plethora of tax incentives available to parents). Plus many of them prefer the perks of apartment style living (and are ineligible for deductions available to homeowners). Lastly, they do not contribute as much to their retirement accounts (which would further decrease their tax rates). Until these single young professionals decide to get married, procreate, and find a home, they should strongly consider investing more of their money. Profit earned from investments can not only add to their monthly incomes, but it can also substantially lower the amount they pay in taxes. A pretty sweet deal, if you ask me.
Do you agree? What things do you think you could start doing to lower your tax rate?