• Category Archives US Tax
  • 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?