How can someone who earns 500k/yr in w2 be in 25% tax bracket?

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boglechu
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How can someone who earns 500k/yr in w2 be in 25% tax bracket?

Post by boglechu » Sat Dec 09, 2017 11:55 pm

I have a friend who supposedly makes $500k/yr as a physician. He formed an Llc to invest in real estate (single family homes). I estimate all the properties total $2 million

He told me his lawyer/accountant got tax bracket lowered to 25% after all deductions but was vague on the details. He has wife and two kids.

Any thoughts? I also make about $500k/yr but don’t have any deductions beyond standard 401k deductions, health insurance for my s-corp, mortgage, and still in 39% tax bracket.

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FiveK
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Re: How can someone who earns 500k/yr in w2 be in 25% tax bracket?

Post by FiveK » Sun Dec 10, 2017 12:06 am

Charitable contributions? Depreciation on the properties?
Deducting country club membership, ski trips, etc. as "business expenses"?

123
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Re: How can someone who earns 500k/yr in w2 be in 25% tax bracket?

Post by 123 » Sun Dec 10, 2017 12:19 am

He may be a poorly organized business person who relies on people who don't know what they're doing causing losses on most things that he tries.

Perhaps he's trying to make a silk pure out of a sow's ear.
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JStephens
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Re: How can someone who earns 500k/yr in w2 be in 25% tax bracket?

Post by JStephens » Sun Dec 10, 2017 12:34 am

My best guess is he only works 1-2 days a week and pulls in around $150k as a physician, and his rental properties throw off no taxable income. More likely, he doesn't know what he's talking about.

MiddleOfTheRoad
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Re: How can someone who earns 500k/yr in w2 be in 25% tax bracket?

Post by MiddleOfTheRoad » Sun Dec 10, 2017 12:42 am

He may be quoting his effective tax rate. You would be surprised how a lot of people don’t know the difference.

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rocket354
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Re: How can someone who earns 500k/yr in w2 be in 25% tax bracket?

Post by rocket354 » Sun Dec 10, 2017 12:46 am

MiddleOfTheRoad wrote:
Sun Dec 10, 2017 12:42 am
He may be quoting his effective tax rate. You would be surprised how a lot of people don’t know the difference.
This is probably the winner.

Katietsu
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Re: How can someone who earns 500k/yr in w2 be in 25% tax bracket?

Post by Katietsu » Sun Dec 10, 2017 12:49 am

His effective tax rate could easily be about 25%. I did a quick estimate making some very reasonable assumptions for depreciation, retirement contributions, property tax and such. I got an effective rate even lower - about 20%.

boglechu
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Re: How can someone who earns 500k/yr in w2 be in 25% tax bracket?

Post by boglechu » Sun Dec 10, 2017 1:17 am

Can you clarify how effective tax rate works in the sample? I am still learning all the tax stuff and trying to get an understanding of how it works.

Suppose My friend has 5 properties in his Llc whose mortgage totals $2,000,000.

I went to online depreciation calculator that says first year is $27,272 and subsequent years is $72,727.

Property tax estimate is $14,300.

In one year, $2,000,000 loan paid over 30 years has $38,382 in principal and $69,388 in interest.

401k: $18,000

Total estimated deduction $173,415
401k: $18,000
Property tax: $14,300
Investment property depreciation: $72,727
Mortgage interest deduction: $68,388.
Maitennance of property
Travel
Home office

Is it the case that investment Llc can deduct 100% of property tax, depreciation, mortgage interest?

boglechu
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Re: How can someone who earns 500k/yr in w2 be in 25% tax bracket?

Post by boglechu » Sun Dec 10, 2017 1:19 am

Again, all these terms very new to me. I just want some sample numbers to better understand general idea of how these deductions work. Thx

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FIREchief
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Re: How can someone who earns 500k/yr in w2 be in 25% tax bracket?

Post by FIREchief » Sun Dec 10, 2017 3:18 am

rocket354 wrote:
Sun Dec 10, 2017 12:46 am
MiddleOfTheRoad wrote:
Sun Dec 10, 2017 12:42 am
He may be quoting his effective tax rate. You would be surprised how a lot of people don’t know the difference.
This is probably the winner.
+2 Bingo. We have a winner.
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Katietsu
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Re: How can someone who earns 500k/yr in w2 be in 25% tax bracket?

Post by Katietsu » Sun Dec 10, 2017 4:04 am

Let’s make it easier than including the complications of 2 million in real estate and home offices.

I am married filing jointly with two kids. I am employed and I have a contract for a salary of $250,000. My husband is a SAHD. I max out a 401k at $18,000. I also put $6000 in an HSA and I am required to contribute $500 per month to health insurance. I take the standard deduction.

So, my taxable income is $250,000 salary -$18,000 401k-$6000 HSA- $6000 insurance premium- $12700 standard deduction-$16,200 exemptions. Or $191,100. Look this up on a chart for tax brackets and you will find that for 2017, this puts me in the 28% tax bracket. This would be my marginal tax bracket or the rate that my last dollar earned was taxed at.

My tax liability is $40393. My effective tax rate is 16%. This number is represents the percentage of my gross income that I must pay in federal income tax. The effective tax rate is lower than the marginal tax bracket because I pay 0% on some income (eg money deducted for my health insurance) and I pay only 10%, 15%, and 25%, respectively for relevant portions of my taxable income in those brackets.

Now, as to the investment real estate, there are many good resources for that. Things like mortgage interest and depreciation that you describe can be fully subtracted from income, ie rent, earned by those properties. If those expenses exceed the income earned on the property, how much of the net negative can be used to lower taxable income from wages is too complicated for me to type out on my phone here in the middle of the night.

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Re: How can someone who earns 500k/yr in w2 be in 25% tax bracket?

Post by livesoft » Sun Dec 10, 2017 5:47 am

Here are some Effective Average Adjusted Livesoft Tax Rate calculations with a worksheet:
viewtopic.php?f=2&t=163748
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Biglaw Investor
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Re: How can someone who earns 500k/yr in w2 be in 25% tax bracket?

Post by Biglaw Investor » Sun Dec 10, 2017 6:42 am

boglechu wrote:
Sun Dec 10, 2017 1:17 am
Can you clarify how effective tax rate works in the sample?
If you haven't spent a lot of time at the White Coat Investor's site, he posts a tax report each year. His income is in the $1+ million and his effective federal tax rate was 21.7% last year (I actually think the second link would be more helpful for you as it has a better breakdown, although it's the 2016 report for 2015 taxes).

https://www.whitecoatinvestor.com/lesso ... 016-taxes/
https://www.whitecoatinvestor.com/2016-tax-report/

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Re: How can someone who earns 500k/yr in w2 be in 25% tax bracket?

Post by jayk238 » Sun Dec 10, 2017 6:59 am

Effective tax rate is not the same as the highest tax bracket. Ie if wo deductions ur highest tax bracket is 33 and ur highest tax bracket is 28 after deductions. then your effective tax is the average of all the brackets you fall in equal to 16.

Taxes are progressive. You only pay the highest tac from the point at which the previous tax bracket ends

This is to clarify the above examples further

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Re: How can someone who earns 500k/yr in w2 be in 25% tax bracket?

Post by solobuildingblogs » Sun Dec 10, 2017 11:05 am

If you invest in property for your practice or multiple satellite offices, there's something called cost segregation analysis which allows you to accelerate depreciation, putting you in a low tax bracket.

Commercial real estate is depreciated over 39 years, but what cost segregation analysis does is break down the cost of the building into individual components that are depreciable over 3, 5, and 7 years (walls, flooring, ceilings, heating and cooling, electrical, lighting permanent furniture and fixtures)- allowing you to take more deductions thus generating more cash flow upfront, which is what most business owners want.

But if you sell the building, you are hit with depreciation recapture at the 28% rate. This may or may not be favorable, if you sell the building when you're retired and in the 10 or 15% bracket you obviously get hit with a higher rate; if you're in the 35% bracket this might be favorable. You also need to take the time cost of money as well as potential stock market gains if the money is invested.

I wouldn't buy a huge building just for the tax advantages though. It's still money outta of your pocket. Commercial real estate is more illiquid compared to personal, and there's something to be said about flexibility to move your office or retire.

We'll eventually have a detailed post up on this...

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Re: How can someone who earns 500k/yr in w2 be in 25% tax bracket?

Post by LadyGeek » Sun Dec 10, 2017 12:13 pm

To keep this discussion actionable (and avoid conjecture on what the OP's friend "might" be doing), let's focus on tax rate and tax brackets.
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Re: How can someone who earns 500k/yr in w2 be in 25% tax bracket?

Post by LadyGeek » Sun Dec 10, 2017 12:15 pm

From: Subject: Calculating Effective Tax Rate
dbr wrote:
Thu Jan 05, 2017 9:53 am
Appeal to authority for definitions:

http://www.investopedia.com/terms/e/eff ... axrate.asp

http://www.investinganswers.com/financi ... -rate-1229

http://www.foxbusiness.com/features/201 ... -rate.html

It is an excercise for readers to decide if all published examples are mutually consistent.

Examples of possible debate are including tax deferred income in income, including value of benefits in income, etc.

As always the best answer may be "it depends" on what you want to know the number for.
The wiki has some background info: Marginal tax rate
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Re: How can someone who earns 500k/yr in w2 be in 25% tax bracket?

Post by Jack FFR1846 » Sun Dec 10, 2017 12:16 pm

Or his LLC pays him a salary. Say $150k a year. Now the LLC pays separate taxes as a business. He's ignoring this as business expenses.
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