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You’ll often hear that the rich benefit the most from the tax code. Read on to see if that’s true or not.
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No matter how much money you earn or have, taxes are something you have to deal with. But you can minimize the amount you have to pay the IRS each year by taking advantage of tax breaks like credits and deductions.
You’ll often hear that the tax code is unfair because it’s designed to give wealthy people the most benefit. But that really doesn’t tell the whole story.
How the wealthy benefit from the tax code
Filers across all income levels can reduce their IRS burden by claiming tax deductions, which serve the purpose of exempting a portion of earnings from taxes. A $1,000 tax deduction means the IRS isn’t taxing $1,000 of income. But that means different things to different filers.
Our tax system is a marginal one, where your highest dollars of income are taxed at a higher rate than your lowest dollars of income. The higher your income, the higher a tax bracket you fall into.
Here’s how that can benefit wealthy people. Let’s say you’re single and earning $250,000 a year, which puts you in the 35% tax bracket. If you claim a $1,000 tax deduction, based on your tax bracket, you get to enjoy $350 of tax savings.
Now, let’s say you’re single earning $50,000 a year. That puts you in the 22% tax bracket. For a $1,000 deduction, you’re getting $220 worth of tax savings, which is clearly less than $350.
Another way wealthy people tend to benefit from the tax code is by taking advantage of long-term capital gains tax rates in their investment portfolios. A single tax-filer earning $250,000 pays just 15% on long-term capital gains, as opposed to 35% on short-term gains, which apply to investments held for a year or less before being sold.
Now to be fair, people of all incomes can take advantage of the fact that long-term capital gains are taxed more favorably than short-term gains. But wealthy people are also more likely to have money to invest with. In fact, the Brookings Institution found that about 80% of the tax benefit from the lower rate on long-term capital gains applies to the top 1% of taxpayers, and 92% of that benefit applies to the top 10%.
When the wealthy don’t benefit from the tax code
It’s true that by nature, the rich can end up with more benefit from tax deductions. And it can also be argued that the wealthy are more likely to get to claim certain tax deductions in the first place.
Take the mortgage interest deduction. Someone earning $250,000 a year is more likely to be in a position to buy a home than someone earning $50,000.
But let’s also remember that certain tax breaks phase out at certain income limits. So the wealthy are commonly excluded from those.
For example, the Child Tax Credit can be a huge source of savings, but it phases out for singles earning $200,000 and married couples earning $400,000. Similarly, education credits like the Lifetime Learning Credit are off the table for singles earning more than $90,000 or married couples earning more than $180,000.
What’s more, the IRS allows tax-filers to deduct medical expenses that exceed 7.5% of their adjusted gross income. Higher earners might spend a lot on healthcare, but they’re less likely to be able to claim this deduction.
Someone earning $50,000 a year can deduct medical expenses once their annual spending exceeds $3,750. Someone earning $250,000 a year can’t deduct medical expenses until their total exceeds $18,750. So in this case, a person earning $250,000 who racks up $18,000 in medical bills (which is a lot of money even for a higher earner) can’t get any tax break at all.
Tax breaks exist for everyone
It’s easy to see why the tax code might seem like it’s set up to favor the rich. But ultimately, there are tax breaks in there for everyone — you just need to know where to look. If you’re a lower earner, for example, you might qualify for the Earned Income Tax Credit, a fully refundable credit that can be worth thousands.
And if you’re not sure what credits and deductions to claim, it could pay to seek help. The IRS’s Volunteer Income Tax Assistance (VITA) program is available to tax-filers earning $60,000 or less. Sitting down with someone knowledgeable could open the door to tax savings you never even knew about.
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