Money Can’t Buy Happiness But It Could Buy Me A Boat

The IRS has released its statistics from 2019 filed tax returns… great, maybe now they can start answering the phone.

This is interesting data and will be utilized for all kinds of important matters, such as:  census data, political wrangling, arguments for/ against income inequality, arguments for/ against “paying their fair share”, informing tax policy and enforcement matters, and measuring contests… to name just a few.

What’s the breakdown? The chart below shows some highlights:Read it like this:

To be considered among the top 1% of income achievers your adjusted gross income must be greater than $546,000 ~ the top 1%’ers collectively report 20% of all income and pay nearly 39% of all personal income taxes.

To be considered among the top 5% of income achievers your adjusted gross income must be greater than $222,000 ~ the top 5%’ers collectively report 36% of all income and pay just over 59% of all personal income taxes.

To be considered among the top 10% of income achievers your adjusted gross income must be greater than $155,000 ~ the top 10%’ers collectively report 47% of all income and pay nearly 71% of all personal income taxes.

In the middle… So between the top 10% and the bottom 50% (there’s no better way to say it, sorry)… your adjusted gross income ranges from $44,000 to $155,000 ~ this group represents 40% of all income earned and 26% of all income taxes paid. This brings the top half of all income achievers to collectively reporting 88% of all income and paying nearly 97% of all personal income taxes.

The bottom 50% of taxpayers report an adjusted gross income of no more than $44,000, represent over 12% of income earned and pay 3% of all personal income taxes.

A few interesting notes:

The top 1% is made up by a group of taxpayers, between 1.4 and 1.5 million of them, and while the break point to enter this club is “just” $546,000 of AGI, their average income is closer to $1,700,000 ~ meaning that there is a large range in this group and there is a significant difference between the top 1% and the top 0.1%!

From the top 1% to the top 0.5% income nearly doubles; from the top 1% to the top 0.1% income more than quadruples; and from the top 1% to the top 0.01%… well, that math takes a calculator to figure. The income reported by that selective group is about 20X what it takes to enter the 1% club.

And what do these fine folks wear to the office to flaunt their earnings? Primarily hoodies.

The Tax Foundation has some nice information, with pictures, that help dive in deep here (note that they have not deciphered the 2019 data yet, so theirs is 2018, but they still get the point across). One aspect of the income generation of the top 1% that the Tax Foundation points out that is particularly interesting to this guy is the correlation with the business cycle. While the share of AGI reported by the top 1% increased over the last two decades, it fluctuated considerably over the business cycle, rising with expansions, and falling with contractions to a greater extent than income reported by other groups.

Another interesting note on these high earners is the makeup of their earnings. According to the Congressional Budget Office (CBO), the top 1% of income earners in the U.S. get more than a third of their income from capital gains. This is in stark contrast to the rest of taxpayers. The next 4% of earners (2%’ers to 5%’ers) earn about 10% of their income from capital gains. Farther down the list, the next 5% (6%’ers to 10%’ers), the amount of income from capital gains continues it’s decline, falling to 5% of income. Additionally, while the capital gain income increases up the income distribution spectrum, labor income decreases.

Importantly, capital gain income, as well as some other investment income gets preferential tax treatment. The rationale for this is that it encourages investment, boosts productivity, raises living standards and stimulates economic growth – that all sounds wonderful! The Net Investment Income Tax (NIIT), which applies to married taxpayers once their income exceeds $250,000 and singles at $200,000 took affect starting in 2013 and targets income and gains from investments and applies additional taxes to these type of earnings. It was the disparity of income generation by source (as discussed above) that drove this tax policy forward.

What are some lessons we can learn here and learn from the 1%’ers?

Be prepared. Business and economic cycles can and do happen and their impact is felt by all and can be more dramatic for those whose income is derived from business sources. Having a healthy balance sheet, having reserves, keeping debt in check, and having product differentiation that allows you to “pivot” are all ways of being prepared to weather a downturn.

Income streams. Broad and diverse. The more the merrier. Working for a living is not a bad thing – but coupling that with passive rental income, investment income (capital income), and/ or business income must be a good thing.

This data is from 2018 & 2019, which is noteworthy, as we really didn’t know what COVID was yet, and certainly the economic impact wasn’t rearing its ugly head. When the data is available for 2020 and 2021 it will be telling and will most likely show a tale of two recoveries and probable further separation amongst these groups.

Is income inequality a good or bad thing? Are they just political buzz-words? Or does it inspire? Do outsized rewards drive innovation and risk-taking ~ that lead to developments that change the world? These are all great discussion ideas to bring up at your next dinner-party – just know that if you do, it will probably be the last time you get invited. The US Census Bureau has some reading for you if you want to go a bit deeper as does a book by Edward Conrad with a fantastically provocative title The Upside of Inequality.

The American Dream is predicated on upward mobility; therefore, income and wealth generation are ingrained in many of us as inherently good. Is joining this exclusive club a desirable goal? Is it desired by all? 1%’ers get a lot of attention ~ both positive and negative ~ is this attention driven by jealously? How much is enough? What really matters? At what cost should we pursue higher levels of income? Is income the right measuring stick? These are fantastic questions, and regardless of where one may fall on the income spectrum, can be challenging to us all in some way.

One fact is obvious though, income taxes can take an oversized bite out of your income if not planned for and addressed properly. Keeping your income is paramount to building wealth, and taxes can be a huge detriment to that endeavor. Whether it is properly structuring your entities and income streams, deferring income into qualified plans, utilizing a well-done tax return to obtain leverage and invest ~ proper income tax planning and mitigation of same is a goal we can all agree upon.

So as we wrestle with this data and the philosophical questions and life style questions it generates, I encourage you all to keep in mind words that could only come from a country song ~ “money can’t buy happiness, but it could buy me a boat”!