One of the most common sources of confusion when it comes to taxes are the tax brackets. Today we’ll explain why people get confused, break it down in simple terms, and in the end, all of you will be experts and will be able to help your misguided friends.
The United States has a progressive tax system. That means that as you make more money, you are taxed at a higher rate. We’ll break that down further in a minute
Once in a while you will hear someone say, “I don’t want a raise, because it will put me in a higher tax bracket and I will end up making less.” These people don’t understand the tax brackets and should read the rest of the article to find out what really happens.
The people who say these things mistakenly think that when you enter a higher tax bracket, all of your income is taxed at the rate of your new tax bracket. That’s actually not how it works. When you do your year end tax calculations, only a portion of your income is taxed at the rate of the new tax bracket.
What Really Happens
The 2010 tax rates for Single Filers are as follows:
We see that anyone who makes up to $8,375 is in the 10% tax bracket while someone making up to $34,000 is in the 15% tax bracket.
While your friend may think that making $20,000 will stick him with $3,000 in taxes, that’s actually not the case. Instead, you are taxed at 10% for every dollar you make UP TO $8,375, and at 15% for every dollar you make between $8,375 and $34,000. So your friend making $20,000 would actually have taxes of $837 (10% of $8,375) plus $1,744 (15% of the difference between $20,000 and $8,375, or 11,625), for a total of $2,581.
That was a very basic example. One thing this doesn’t account for is the standard deduction as well as the personal exemption deductions (amounts you dont have to pay tax on). The best way to quickly find your federal tax rate is by checking out this tax calculator to find out your tax rate. It also tells you how much total taxes you pay and shows what your “real tax rate” is.
Your “real tax rate” is the percentage of total income you spend on taxes. Using the calculator, someone earning $50,000 has total taxes of $5,944, which is 11.89% of total income in taxes. That’s less than half the 25% your friend at the beginning thought he’d have to pay!
Do you have a better understanding of tax rates? So next time you hear someone considering a raise, you’ll be able to tell them that of course they should take it!