Question: Phil Mickelson and Tiger Woods are America’s highest paid golfers. In January, Phil Mickelson said that federal and California taxes are making him consider making some “drastic changes.” It was widely assumed that one of those changes will be to move to a no-income-tax state like Texas or Florida. Bloomberg News reported that Mickelson unloaded his ownership interest in the San Diego Padres last December, a move he admittedly made for tax reasons. Woods recently stated publicly that he moved from California to Florida in 1996 “for that reason,” referring to Mickelson’s recent statement that a tax burden of more than 60% seems excessive. How can Mickelson’s tax rate be as high as 60%?
Answer: I have been asked this question enough to instigate a column. The simple math of adding the top federal (39.6%) and state (13.3%) tax rates together doesn’t work. To figure this out, let’s listen in on a mock meeting between another highly compensated golf pro, Lefty Mulligan, and Joe Tacsmann, his financial advisor:
Lefty: As you know, I had another good year in 2012 and I expect it to continue. I expect to earn $60 million this year, most of it from endorsements. I wasn’t happy when you had me write that check for the extra $1.8 million for my January estimated tax payment to California for 2012. I’m now paying $8 Million in income taxes to California! Remind me what that’s all about.
Joe: If you recall, Lefty, California voters approved Proposition 30 last November. They approved increasing California’s top tax bracket from 10.3% to 13.3%. And, believe it or not, they made it retroactive to January 1st .
Lefty: Holy Fairways! They can do that? What’s next? Let’s do some serious tax planning. What do I have to look forward to in 2013?
Joe: Well, Congress just passed the American Taxpayer’s Relief Act of 2012. They could have named it the American Taxpayer’s Income Redistribution Act to honor highly paid sports pros like you. That law raised your top federal bracket from 35% to 39.6%.
Lefty: 39.6% plus 13.3% means I’ll be paying over half my earnings in taxes.
Joe: It gets worse, Lefty. At your level of income, you lose your personal exemptions and 80% of your itemized deductions, meaning that most of the money you pay in state taxes is double-taxed by the Feds, and those charitable contributions you were planning won’t help. Remember too that you are self-employed, so you will be paying 15.3% of your income in social security and Medicare taxes on the first $113,700 and then 2.9% up to $250,000 and then 3.8% on all your earned income above that.
Lefty: Holy Divots! Let me get this straight. I will be paying 39.6% federal, 13.3% state, and 3.8% Medicare tax on most of my income. That adds up to 56.7%!
Joe: Believe it or not, it gets worse. Remember the affordable care act that Congress approved and the President signed in 2010? It included a new, additional 3.8% tax on your investment income.
Lefty: Holy Caddyshack! You’ve got to be kidding! I’ve worked tirelessly to be the best and my “fair share” in taxes is 60 cents of every dollar I make?