How the Tax Code Crushes Labor Income

We just wrapped up our taxes for 2024, and all I can say is…ouch. Between our federal and state balance payments for 2024 and estimated taxes for Q1 2025, we had to send out about $170,000 this week. I still can’t wrap my head around it, that’s a huge amount of tax to pay all at once. That’s more than what most people make per year.

Of course this is a first world problem. My income increased from about $1.4 million in 2023 to $2 million in 2024. Most of my income from clinical work is from “bonus” payments related to productivity, and from a withholding standpoint, the first $1 million of bonus income is automatically withheld at only 22%. In 2024, we used the safe harbor rule to come up with our estimated tax payments. So if there’s a significant increase in income, it’s expected to have a big balance in April. Consider it an interest-free loan from the government I guess?

We also got hit by our ASC investment. I’m not involved with the management or capital allocation of the ASC, so I’m just an equity holder. I received about $68,000 of distributions in 2024, which I thought was pretty good. When I looked at the K-1 though, for my share of the ASC, they reported about $100,000 of ordinary income. That means I owed roughly $50,000 in taxes, which adds up to just $18,000 of after-tax distributions in my pocket. Not so great after all.

Later this year, I might have an opportunity to invest more in the ASC if I wanted to. It sounds attractive, usually they’ll project about 30-40% pre-tax income every year. But between taxes and the retained earnings not distributed, in 2024 I made a 7.9% after tax return on my capital that was invested at the beginning of 2023. Meanwhile, with the stock market volatility recently, I see opportunities to buy shares of companies that are high-quality, with high ROIC, very strong balance sheets, growth prospects, and high margins trading at prices that project future returns greater than 15% compounded. And as long as we hold and not sell, that’s compounded growth tax-free.

This is a prime example of how the US tax code punishes the labor class. The tax code is a set of incentives that the government uses to create the type of economic activity that they want to happen. For me, capital appreciation in assets held are completely tax free, while my clinical income has a margin tax rate over 50%. And even if I do sell, long-term capital gains are taxed much more favorably than labor income.

So again, the goal for everyone in the labor class, including most high income professionals, is to convert as much of their labor into capital as possible.