Asymmetrical Information - Megan McArdle

11.21.12

Still More Tax Wrinkles

The tax code hits harder than we expect

From the comments of my post on deduction phaseouts

Here's another example:

I have earned about $110,000 so far this year. If you earn more than $115,000 this year, then next year you're considered a 'highly compensated employee' and your participation in the company 401(k) is limited, in my case to 3% of salary. This is based on how much the non-HCEs contribute, and apparently my coworkers are all very irresponsible. (Actually, I work for a company that mostly employs temp workers, very few long-term employees.)

I just learned this a week ago. I'm an hourly employee, and my pay year ends on December 9th. So, I'm working sparse hours for the next few weeks to stay below the $115k line. It's a bright line, no phase-out or anything like that. If I cross the line, my maximum 401(k) contribution next year will be around $3600 instead of $17,500. Assuming that the ability to shift income via a 401(k) saves 10% of its value in taxes, it'll cost me about $1400 to work that hour, and it would then take a week or so to make it up.  

This is a basic problem wtih means testing.  But it's not necessarily an argument against means testing so much as it is an argument for very long phaseout periods--and especially, for staggering the phaseouts so that they don't all hit in the same income range.  This is why the poor can face marginal tax rates that exceed 100%: hit a certain income range, and your EITC, Medicaid, food stamps, and other forms of assistance all start to phase out at once.