Saturday, 20 October 2012

Does US Tax Make Sense?

Realising that we are going to have to start filing a US tax return at the end of the year (the US financial year runs from January to December), I started to look into how the tax system works and what forms we need to fill.

I have not figured out all the complexities of their system but I believe we are going to change the classification on our LLC so that it is classed as a corporationn(C Corp) for tax purposes.

I remember seeing C Corp and S Corp when we were first setting up the LLC, but did not know the repercussions of each class, so we ended up going for the default partnership arrangement. Unfortunately, if we leave it as this, it means that both us will need to apply for an ITIN and file individual tax returns. Essentially each tax return will declare 50% of the income and deductions and you also have to file a tax return for the LLC.

While I was looking at the rate of tax paid in the US system, it made me realise that the way Australian tax is done is a lot simpler and seems to make a lot more sense. What I mean by this is the amount of tax paid is linear, as you earn more, you pay more tax. Whereas, in the US system, it is has big steps between the brackets. I will show you what I mean:

10% on taxable income from to $8,700, plus

15% on taxable income over $8,700 to $35,350, plus

25% on taxable income over $35,350 to $85,650, plus

28% on taxable income over $85,650 to $178,650, plus

33% on taxable income over $178,650 to $388,350, plus

35% on taxable income over $388,350

You can see that there is no tax free threshold like there is in Australia (currently $16,000), and there is no marginal rate for amounts over a certain amount. What does this mean? Let's look at the following situation:

Person A earns $35,300 in annual income - pays a rate of 15% tax, so net income becomes $30,005

Person B earns $35,400 in annual income - pays a rate of 25% tax, so net income becomes $26,550

It is amazing isn't it, Person B earns more income, yet because of how the US tax system is setup, it forces him to be taxed more and end up with a lower net income! It really does not make sense. I am tempted to ask my US accountant if this is true. It would make me want to ask my boss for a "de-raise" if I was close to one of the brackets or look at what tax deductions I could claim to lower my taxable income. What do you think?


  1. Who is your USA acountant?
    And did you go with C corp or S corp?

  2. Hi Kimberley,

    We don't have an accountant in the US at this stage. We didn't need one to purchase our property but will see how it goes when we file our first tax return shortly. We'll be looking to change our LLC structure to a C corp to lower the tax.

    Bhy the way, your blog looks interesting. Where are you based? We're currently looking at getting a couple more properties with a loan.