Tuesday Tips is a series of articles from local experts to help you save money, make better decisions and plan for a better future.
Tax laws are certainly confusing. One of most misunderstood parts is the ‘tax bracket.’ To summarize, your ‘tax bracket’ is not the percentage of your income that you pay in tax. If your ‘tax bracket’ is 20 percent, you are not paying 20 percent of your income in taxes. Our tax system is actually a progressive one, where we are taxed at different levels as our income increases.
For example, if you filed as a single individual this year, here is your tax burden:
10% Tax Bracket – $0-$8,375
15% Tax Bracket – $8,375-$34,000
25% Tax Bracket – $34,000-$82,400
28% Tax Bracket – $82,400-$171,850
33% Tax Bracket – $171,850-$373,650
35% Tax Bracket – $373,650+
If you total income was only from wages, and you made $50,000, you are not taxed on the $50,000. This amount is what the IRS calls your Adjusted Gross Income (AGI). From the AGI, and without getting into other exceptions and adjustments, you deduct your standard deduction of $5,700, and your personal exemption of $3,650. The balance of $40,650 is your ‘Taxable Income.’ This is the amount you are taxed on, computed as follows:
Using the above table, this taxpayer’s burden is 10 percent for the first $8,375 of their income, at 15 percent for everything between $8,375 and $34,000, and so on, up to the total amount of their income.
$837.50 in the 10% Tax Bracket – $8,375 x 0.10.
$3,843.75 in the 15% Tax Bracket – On the next $25,625 x 0.15 (between $8,375 and $34,000).
$1,662.50 in the 25% Tax Bracket – On the balance, or $6,650 x .25 (between $34,000 and $40,650).
So, this taxpayer, whose gross income is $50,000, is paying taxes on $40,670, or $6,343.75.
Although he is considered to be in the 25 percent tax bracket, his effective tax rate is a much lower 15.6 percent (Taxable Income, $40,650, divided by his actual income tax, $6,343.75).
Now you know, and can breathe a sigh of relief.
Joseph Reisman, of Joseph S. Reisman & Associates, has been serving tax prep and business accounting expertise from his Coney Island Avenue office for more than 25 years. Check out the firm’s website.