What were the combined federal and state, corporate and individual income tax rates in Colorado for the investment income of high income taxpayers who are married filing jointly in 2019?
Corporations
The current C corporation tax rate in Colorado which is always a flat rate, is 21% federal and 4.65% state. This is 25.65% combined. (Prior to 2018, most C corporation income in Colorado was taxed at a combined 39.65% rate. The new rate is particularly helpful for marijuana firms that can't take most overhead deductions due to IRC § 280E.)
The Obamacare net investment income tax not apply to C corporations.
C Corporations do not pay a reduced rate for capital gains or qualified dividends (but do have a dividends received deduction omitted from this summary which depends upon what percentage of the shares of the dividend paying company are owned by the taxpayer corporation).
Capital gains and qualified dividends for married filing jointly taxpayers
The current tax rates on long term capital gains and qualified dividends at the federal level are 0%, 15% and 20% plus 4.65% of state income tax.
Capital gains and qualified dividends 10% and 12% bracket capital gains are taxed at 0% at the federal level and 4.65% under the Colorado state income tax for a combined tax rate of 4.65% (up to $78,950 of income if a taxpayer is married and filing jointly). However, Colorado taxpayers pay a 15 percent federal income tax rate and 4.65% state rate on those capital gains if their income exceeds $78,950 up to $488,850 for married filing jointly taxpayers in 2019.
But, capital gain and dividend taxes are also subject to an Obamacare net investment income tax of 3.8% above a certain level. The net investment income tax of modified adjusted gross income thresholds for 2019 of $250,000 if you're married and filing jointly. This amount isn't indexed for inflation. Modified adjusted gross income isn't exactly comparable to taxable income which applies to the other tax brackets, since it is not reduced by below the line tax deductions, but that adjustment is ignored in this analysis. The actually cutoff will usually be $225,600 or less for married taxpayers filing jointly and I will use that cutoff here, even though it could be lower for itemizers.
The combined federal and state income tax rates on capital gains and qualified dividends for married taxpayers filing jointly are:
28.45% ($488,851 plus);
23.45% ($225,601-$488,850),
19.65% ($78,951-$225,600), and
4.65% ($0-$78,950).
Ordinary investment income for married filing jointly taxpayers
The current tax rates on ordinary income such as interest, unqualified dividends and short term capital gains (i.e. under one year) are 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent, and 37 percent. In addition there is 4.65% state income tax on all such income and the 3.8% Obamacare net investment income tax over $250,000 of modified adjusted gross income.
The individual level ordinary investment income tax rates for married filing jointly taxpayers are:
45.45% ($612,351 plus),
43.45% ($408,201-$612,350),
40.45% ($321,451-$408,200),
32.45% ($225,601-$321,450);
28.65% ($168,401-$225,600);
26.65% ($78,851-$168,400),
16.45% ($19,401-$78,950), and
14.45% ($0 -$19,400).
Combined corporate and shareholder level taxes on corporate profits realized as dividends or capital gains at the shareholder level
The combined income tax rates on corporate profits distributed as qualified dividends or long term capital gains to married taxpayers filing jointly are:
46.802575% ($488,851 plus).
43.085075% ($225,601-$488,850).
40.259775% ($78,951-$225,600), and
29.107275% ($0-$78,950).
The combined rates on profits distributed as non-qualified dividends or short term capital gains are:
59.442075% ($612,351 plus);
57.955075% ($408,201-$612,350);
55.724575% ($321,451-$408,200),
49.776575% ($225,601-$321,450),
46.951275% ($168,401-$225,600),
45.464275%($78,951-$168,400),
37.880575% ($19,401-$78,950), and
36.393575% ($0-$19,400).
The combined corporate and shareholder level taxes on corporate profits realized as dividends or capital gains at the shareholder level doesn't tell the whole story, however, because if profits are not distributed to C-corporation shareholders, the shareholder level tax can be deferred given the corporation the ability to continue to earn income on profits that would have been taxed at both levels if distributed as dividends and then reinvested. So, the effective tax rate of companies that defer shareholder realization of gain is overstated by the rates above, even if the shareholder eventually realizes the gain.
Footnote re earned income and Social Security/Medicare taxation
In addition to income taxes there are FICA or self-employment taxes on earned income. This is not payable on investment income. FICA is owed on wage and salary income at 7.65% employer and 7.65% employee up to $132,900 per employee in 2019, and 1.45% employer and 1.45% employee on wage and salary income in excess of that amount.
A similar tax, in lieu of FICA, called the self-employment tax, is imposed on active self-employment income in lieu of FICA, with some very subtle differences in how it is calculated (it is 15.3% of 92.35% of self-employment income up to $22,018 per self-employed person, plus 2.9% of the appropriate share of the remaining self-employment income, with income reduced in an above the line deduction for income tax purposes of self-employment taxes paid).
The active business profits allocated to an active partner in a partnership or an active member of an LLC is subject to self-employment taxation but not FICA.
The share of profits of a shareholder in an S-corporation is not subject to self-employment taxation or FICA, but the IRS can deem some S-corporation profits to be salary instead if the salary of a shareholder of an S-corporation who actively works in the business is artificially too low.
Dividends from a C-corporation are also not subject to self-employment taxation or FICA. Since amounts paid as dividends of a C-corporation are also not subject to self-employment taxation or FICA, and the IRS rarely adjusts the salary of an active C-corporation owner for being too low, owning a C-corporation and working without pay in it in exchange for dividends which aren't subject to self-employment taxation or FICA, can have a similar tax effect to working as a sole proprietor if the shareholder gets income from long term capital gains or qualified dividends. Comparisons are complicated by the fact that there are far fewer deductions from self-employment income than from income tax income (e.g. there are no deductions for health insurance, for traditional IRA contributions, or for the Standard Deduction for self-employment taxes).
A lot of tax planning is driven by these (and other) subtle distinctions between entity forms and the character given to different kinds of compensation.
Tax Reforms
The best alternatives to the status quo to simplify the system and make it more sound and less prone to manipulation and more fair and rational related to the points discussed in this post would be to:
* Allow C corporations to deduct dividends (as currently defined for tax purposes) paid from income for corporate income tax purposes.
* Eliminate the dividends received deduction for C corporations and the accumulated income tax and the personal holding company taxes.
* Subject S-corporation profits and C-corporation dividends paid too active shareholders to self-employment taxation.
* Deduct self-employed health insurance payments from self-employment income.
* Increase the flat federal income tax rate on C corporations to 40%.
* Tax long term capital gains and qualified dividends and other capital gains at the same tax rate as ordinary income, and end depreciation recapture rules.
* Repeal IRC § 280E.
* Repeal the earned income credit and replace it with a refundable income tax credit dollar for dollar for self-employment taxes paid and FICA taxes paid by individuals, and an income tax credit dollar for dollar to employers against FICA taxes that they pay.
* Replace the 10 percent, 12 percent, 22 percent, 24 percent tax rates with a 25% tax rate.
* Replace the 32 percent, 35 percent, and 37 percent rates with a 40% tax rate.
* Repeal the Obamacare net investment income tax.
Tax Reforms
The best alternatives to the status quo to simplify the system and make it more sound and less prone to manipulation and more fair and rational related to the points discussed in this post would be to:
* Allow C corporations to deduct dividends (as currently defined for tax purposes) paid from income for corporate income tax purposes.
* Eliminate the dividends received deduction for C corporations and the accumulated income tax and the personal holding company taxes.
* Subject S-corporation profits and C-corporation dividends paid too active shareholders to self-employment taxation.
* Deduct self-employed health insurance payments from self-employment income.
* Increase the flat federal income tax rate on C corporations to 40%.
* Tax long term capital gains and qualified dividends and other capital gains at the same tax rate as ordinary income, and end depreciation recapture rules.
* Repeal IRC § 280E.
* Repeal the earned income credit and replace it with a refundable income tax credit dollar for dollar for self-employment taxes paid and FICA taxes paid by individuals, and an income tax credit dollar for dollar to employers against FICA taxes that they pay.
* Replace the 10 percent, 12 percent, 22 percent, 24 percent tax rates with a 25% tax rate.
* Replace the 32 percent, 35 percent, and 37 percent rates with a 40% tax rate.
* Repeal the Obamacare net investment income tax.
2 comments:
Hi Andrew,
How would these changes (your suggestions) affect folks (net) on the lower end of tax brackets?
One of my kids is low income. Household income around 60k with no kids. My appreciation of her tax situation is that mandatory medical insurance increases her effective tax rate about 100%. How would she be affected?
Cheers,
Guy
The 2 pertinent parts are: "* Repeal the earned income credit and replace it with a refundable income tax credit dollar for dollar for self-employment taxes paid and FICA taxes paid by individuals, and an income tax credit dollar for dollar to employers against FICA taxes that they pay.
* Replace the 10 percent, 12 percent, 22 percent, 24 percent tax rates with a 25% tax rate."
Basically, what this does is create a situation with a combined payroll and income tax marginal rate of 0% up to the Standard Deduction (about 24K of AGI), and then combined payroll and income tax rates of 25% up to about $100K of AGI. It also makes it less expensive for employers to hire low wage workers at any given wage. For example, it allows an employer to pay $14 per hour at the cost of a $13 per hour worker in the status quo. But, overall is close to revenue neutral with only a modest tax cut to lower income workers.
But it helps low $$ taxpayers by:
1. Making tax returns much easier to do (less time and money to tax prep) with much lower audit risk (the working poor has the most audits now due because EITC is hard). This also means that withholding tax will more closely track tax due so fewer and smaller end of year tax checks to write, and fewer and smaller refunds too.
2. Eliminates all payroll and income taxes for the working poor, instead of first providing welfare at very small $$ and then very high marginal tax rates just a little bit later, as it does now.
3. Ends extremely high marginal tax rates (more than 50% now) as EITC is phased out for the working poor trying to break into the middle class, making the effort seem futile for them. In general marginal rates are much more stable.
4. This removes a tax penalty for self-employed people that buy health insurance vis-a-vis people with employer provided health insurance.o
5. The capital gain/corporate tax change ends a big incentive to trade machines for labor in the tax code when absent taxes labor would make more economic sense preserving jobs at the margins.
6. The corporate tax change discourages piling up big cash reserves as tech firms do today in many billions getting $$ back into the economy which favors job creation.
7. The corporate tax change discourages excessive leveraging with debt rather than equity, which makes firms more robust in recessions. So, less layoffs and business failures in downturns. But, this means growth is less charged in upturns.
8. This prevents big windfalls for a subset of the rich now, which is good for the economy since the rich spend $$ on stuff with lower multipliers than the less rich.
9. This makes tax and financial tricks less useful which shifts resources from gaming the system, in ways that are dead weight loss or favors decisions that would be bad ones but for tax considerations, to uses that favor economic value in terms of fundamentals helping those economy and promoting job creation.
10. This means the marijuana industry won't need the same huge margins just to cover taxes and that will reduce marijuana prices and tax fraud in that industry.
Not a cure all but solve a lot of deep tax code flaws that spill over everywhere.
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