Where does $250,000 a year go?

By Karen Hube
The Fiscal Times
Sunday, December 12, 2010; G01

In the heated battle over extending the expiringBush-era tax cuts, a single number has emerged from the crossfire: $250,000. It's the annual income that President Obama and others have repeatedly used to define what it means to be "rich" in America today. And even though a tentative deal has been reached on the cuts, $250,000 is etched in the minds of policymakers and pundits as the number that separates the middle class from the wealthy.

By any measure, a $250,000 household income is substantial. It is six times the national average household income, and just 2.9 percent of couples earn that much or more. "For the average person in this country, a $250,000 household income is an unattainably high annual sum - they'll never see it," says Roberton Williams, an analyst at theTax Policy Center, a nonpartisan think tank in Washington.

Just how flush is a family of four with a $250,000 income?

To find the answer, this analysis considers the household budget, piece by piece, from housing costs to health care, Internet service to summer camp for kids, and even the cost of the dog. And of course: taxes.

BDO USA, a national tax accounting firm, computed the total state, local and federal tax burden of a hypothetical two-career couple with two children, earning $250,000. To factor in varying state and local taxes, as well as drastically different costs of living, BDO placed the couple in eight locales across the country - including the District, Alexandria and Bethesda - with top-notch public school districts using national data on spending.

The outtake? They're comfortable. They're secure. But they're not Donald Trump.

The analysis assumes that this couple - let's call them Mr. and Mrs. Jones - are both working professionals. They take advantage of all tax benefits available to them, such as pre-tax contributions to 401(k) plans and medical, child care and transportation flexible spending accounts.

They have no credit card debt, but Mr. Jones racked up $40,208 in student loan debt in undergraduate and graduate school, and Mrs. Jones borrowed $22,650 to get her undergraduate degree (both amounts are equal to the national averages for their education levels). They also have a car loan on one of two cars, and a mortgage for 80 percent of the value of a typical home in their communities for a family of four, which includes a toddler and one school-age child.

The bottom line: Living in high-tax areas on either coast can leave our $250,000-a-year family with little margin. Even with an additional $3,000 in investment income, they end up in the red - after taxes, saving for retirement and their children's education and a middle-of-the-road cost of living - in seven of the eight communities in the analysis.

The worst: Huntington, N.Y., and Glendale, Calif., followed by the District, Bethesda, Alexandria, Naperville, Ill. and Pinecrest, Fla. In Plano, Tex., the couple's balance sheet would end up positive, but only by $4,963.

Taxes take a hefty toll. Everything from property taxes and the alternative minimum tax to the taxes tacked on to cellphone bills and the cost of gas, when combined, takes a large bite out of earnings - in some cases even more than the federal income tax toll. And it's not likely to get better anytime soon. States and municipalities have been steadily raising income tax rates to close gaping holes in their budgets.

Property taxes are also increasing even though real estate values have cratered. And sales taxes are hitting record levels, in some areas nearing 10 percent. Gas taxes, alcohol taxes and surcharges on things such as flights, ferry rides, soda, vehicle registrations and rental cars have also climbed.

Additional tax increases for couples with salaries of $250,000 or more (and singles earning $200,000 or more) are scheduled to go into effect in 2013 under the health-care bill passed in March.

Meet the Joneses

Being in the red on a $250,000 annual salary might still seem surprising. But taking responsibility for their retirement and their children's future is costly. They are maximizing contributions to two 401(k)s and all flexible spending accounts available to them, and they are squirreling away $8,000 a year into college funds.

Their spending is conservative, based on national averages for professional couples with two children. Not included are those run-of-the-mill payouts for charitable deductions, life insurance premiums, disability insurance, legal fees - or monthly sessions at the salon or gym membership.

As educated professionals, they buy books, newspapers, magazines; they own computers and pay for Internet access.

But the Joneses don't take lavish vacations. They don't belong to a country club, play golf or drive luxury cars. They don't have a swimming pool or buy designer clothes. They don't own or rent a second home and don't send their children to private school. And they don't shop for groceries at high-end markets (they spend what the Department of Agriculture defines as a "moderate" amount on food for the average family of four).

In reality, to make ends meet, this couple would have to cut back on discretionary expenses - take a pass on a new suit, skip an annual vacation and drop some activities for the children. Unfortunately, the family would also probably save less, at the expense of retirement or college funds.

"A family earning $250,000 should be saving more, not less," says Rocky Cummings, BDO's national director of state and local taxes. "Saving less isn't going to cut it for their retirement."

Consider the tax profile of the Joneses when based in Huntington, a suburb of New York City. Thanks to all of their smart pre-tax contributions and a fat deduction for mortgage interest and state and local taxes, the couple's federal income tax is only $29,344. But what often goes overlooked is the toll taken by state and local taxes. In this case, it exceeds the federal income tax bill: $29,864.

State income taxes, taken alone, are $10,557. But factor in the gas tax ($1,545), property ($15,222), phone service taxes and surcharges ($350) and sales ($848), and the picture changes. Their total tax bill, including the AMT and payroll taxes: $77,074.

"When most people think about taxes, they think first about federal income taxes, then maybe about sales taxes, but there are a lot of taxes out there," says Mark Robyn, an economist with the Tax Foundation a nonprofit tax research group in Washington. "It's eye-opening to step back and take a look at the whole picture."

The Joneses would fare somewhat better in the Washington area. If they lived in the city, they would pay $29,909 in federal income taxes, $177 in alternative minimum tax and $15,299 in payroll taxes. Add to that the $20,067 in state and local taxes and you get a total of $65,452.

Moving to a state with no income taxes or low taxes in general would do more to help the Joneses' bottom line.

In Pinecrest, Fla., a suburb of Miami, they would owe zero state income tax, and pay an annual $10,976 in property taxes, $1,833 in sales taxes and $350 in phone service taxes, for a total state and local tax burden of $14,453. Because they would have no deduction for state and local taxes on their federal tax return, they would have to pay Uncle Sam more than they did in Huntington: $31,768. Still, the total tax burden would be significantly less: $61,621, vs. $78,276 in Huntington and $71,683 in Glendale, a suburb of Los Angeles.

But for many people, moving to a low-tax state in mid-career is difficult if not impossible. People are generally bound to their high-tax states by their jobs. And often it's tough to find high salaries in low-tax states such as Florida.

What $250,000 buys

The $250,000 threshold was first mentioned in a campaign speech by Obama in 2008. "It's an historical accident," Williams says. "I don't think there was any thought given to why $250,000 - it became a mantra."

Whether $250,000 represents affluence "depends a great deal upon where you live," he says.

Consider, for example, the tab for the same assortment of ground beef, tuna, milk, eggs, margarine, potatoes, bananas, bread, orange juice, coffee, sugar and cereal: In Twin Falls, Idaho, $23.41. In New York City, you would shell out $40.29, or 72 percent more, according to the Council for Community and Economic Research. That higher percentage carries across all expenditures, from child-care costs to haircuts.

Of course, housing costs are one of the biggest variables. In Glendale, the Joneses can live reasonably well - but not extravagantly - in a three- or four-bedroom home valued around $750,000. In Twin Falls, they would need to spend about half as much on an equivalent home.

After covering taxes and only essential expenses for housing, groceries, child care, clothing, transportation - and their dog, the Joneses would still be in the red by $1,787 in Huntington.

In Alexandria, the couple would be in positive territory with $15,313; in Bethesda, they would be up by $14,187 and in Washington, by $12,036. In Plano, Tex., the best-case scenario of all the locales in the analysis, they would have $27,556 to spare.

But factor in common additional expenses for a working couple with two children - music lessons, day camp costs and after-school sports, entertainment, cleaning services, gifts and an annual week-long vacation - the Joneses get deeper in the red in Huntington, to the tune of $24,380. In Alexandria, they would be down by $7,280. In Bethesda, it would be $8,406, and in Washington, $10,557. In Plano, the best-case scenario, they would have $4,963 to spare.

Some of the expenses incurred by couples like the Joneses might seem lavish - such as $5,000 on a housecleaner, a $1,200 annual dry-cleaning tab and $4,000 on kids' activities. But those are the sort of expenses that households with two working parents might juggle as they try to maintain the home, care for the kids and dress for their professional jobs.

And costs assumed by the Joneses could be significantly higher if their circumstances changed. If they worked for themselves, for example, they would have to foot the bill for all of their medical insurance premium, which averages $14,043. As it is, they pay 30 percent of the premium, and their employers pay the rest.

Bottom line: For folks like the Joneses who live in high-tax, high-cost areas, who save for retirement and college, pay for child care to enable two incomes and spend higher prices for housing in top school districts, $250,000 goes quicker than you might think.

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