There has been great debate over the years about whether our tax system is fair and who is getting the short end of the stick. Some contest that the tax code has always favored the rich, while others maintain that virtually all Americans pay way too much in taxes, and some even think Americans don't pay enough tax. Of course, the definition of what is right and fair in this sense is somewhat subjective. There are some who feel that the tax code as it is written now offers some incentives for those who don't work for a living at all.

The Estate Tax
Although the Unified Tax Credit is planned to revert to $1 million per person in 2013, the tax code has allowed wealthy taxpayers to transfer up to $10 million of their assets to heirs (other than spouses or charities) with no estate tax in recent years. While doing so may be easier said than done for low- and middle-income taxpayers, some tax experts and politicians feel that the wealthy have received a pass on inheritance taxes that is inappropriate. They contend that those with substantial estates should have to fork over some of that money to Uncle Sam when they die. If the inheritances left by the wealthy in 2009 had been subject to income taxes, the total bill would have come to approximately $90 billion that could be used to improve our education and infrastructure or reduce the deficit.

Investment Income
The tax code clearly seems to favor investors over workers when it comes to taxation. Although some types of investment income, such as short-term capital gains, are taxed at rates comparable to ordinary income, they are never subject to payroll taxes of any kind. Social Security, Medicare and FUTA are never withheld from any type of investment payout, regardless of its nature. Long-term capital gains have been taxed at an ever lower rate, and investors in the lowest tax bracket have had a 0% rate on their long-term gains for the past few years, although this rate will increase in 2013 if the fiscal cliff cannot be avoided. Of course, these tax breaks were designed to encourage people to save and invest money and stimulate the markets, but those with enough wealth to live off of their investment income without working have clearly benefited the most. Municipal bonds offer the greatest tax savings to wealthy investors, as their interest is tax-free at the federal, state and local levels (although this type of interest can become an AMT preference item if enough of it is paid during the year).

Earned Income
People who work for a living pay several types of taxes. Not only is their earned income taxed as ordinary income, it is also subject to other taxes like Social Security and Medicare withholding, which amounts to 7.65% of their pay up to the amount of the Social Security wage base if they are employees - and twice that amount if they are self-employed. Taxpayers with Schedule C income can generally expect to pay about half of their income away in a combination of income and payroll taxes. Furthermore, current tax rates can go as high as 35% for high-income earners, and that doesn't even include state or local taxes. Therefore, someone who earns $400,000 in a year can reasonably expect to pay at least a third of that to Uncle Sam, whereas someone who realized a long-term capital gain of that amount would only pay 15% in 2012. Someone who inherited that amount would pay no tax.

The Bottom Line
The argument about whether the tax code favors those who don't work is not going to be resolved any time soon. Taxpayers can only look at their own situations in order to find out what they can do to minimize their own taxes and act accordingly. For more information on the taxation of various types of income, visit the IRS website, or consult your tax or financial advisor.

Related Articles
  1. Taxes

    Tax Breaks For Volunteering

    Your volunteer ventures could earn you some welcome tax deductions, along with the satisfaction of helping others.
  2. Taxes

    Six Ways Your Tax Preparer Knows You’re Lying

    Cheating on your taxes is asking for trouble. You might get away with it, but you’re playing with fire and likely to get burned.
  3. Taxes

    How & Where to File Form 1040 (And Which Version)

    All taxpayers need to know three things when filing a 1040: which form to use, how to file and where to file. After reading this, you'll know all three.
  4. Savings

    Should You Look at 529 Plans Outside Your State?

    529 savings plans are not restricted by geography. So if your in-state offering has high fees or poor investment choices, look elsewhere.
  5. Taxes

    The Purpose Of The W-9 Form

    The W-9 form provides key data your clients need if you're an independent contractor. Just be sure you're not really an employee who should fill out a W-4.
  6. Retirement

    Pros and Cons of Deferred Compensation Plans

    Learn about the pros and cons of non-qualified deferred compensation (NQDC) plans, including the flexibility of non-ERISA plans and the potential for forfeiture.
  7. Taxes

    Revisiting the Internet Sales Tax Bill: 2013 Vs. 2015

    Learn about the Marketplace Fairness Act of 2015 being reviewed by congress and the differences between it and the 2013 Marketplace Fairness Act.
  8. Taxes

    5 States Without Sales Tax

    Learn about the five states that do not charge sales taxes and about other taxes the states levy instead in order to generate revenue.
  9. Investing Basics

    Internet Sales Tax's Effect on Interstate Commerce

    Find out how a national Internet sales tax could affect interstate commerce, and why some bigger online retailers are lobbying for such a tax.
  10. Taxes

    10 Money-Saving Year-End Tax Tips

    Getting organized well before the deadline will curb your frustration and your tax liability.
  1. Do tax brackets include Social Security?

    A portion of your Social Security benefits may be subject to federal taxation using tax brackets. Your tax bracket is determined ... Read Full Answer >>
  2. Are personal loans tax deductible?

    Interest paid on personal loans is not tax deductible. If you take out a loan to buy a car for personal use or to cover other ... Read Full Answer >>
  3. Does a Flexible Spending Account (FSA) cover braces?

    Funds from a Flexible Spending Account (FSA) can be used to cover costs associated with installing, maintaining and removing ... Read Full Answer >>
  4. Does QVC charge sales tax?

    QVC, an American TV network, is registered with states to collect sales or use tax on taxable items. QVC is also required ... Read Full Answer >>
  5. Do 401k contributions reduce AGI and/or MAGI?

    Traditional 401(k) contributions effectively reduce both adjusted gross income (AGI) and modified adjusted gross income (MAGI). ... Read Full Answer >>
  6. Does a Flexible Spending Account (FSA) cover glasses?

    The funds in a Flexible Spending Account (FSA) can be used to cover most common medical expenses; this includes the cost ... Read Full Answer >>

You May Also Like

Trading Center