Saturday, January 19, 2013

Dispelling the Income Tax Bracket Myth

One of the more notorious myths associated with tax season is that by earning more money in a tax year an individual could get pushed into a "higher tax bracket" and thus earn less money.  This simply isn't the case with a progressive tax system.  There are scenarios where an individual can end up paying more in taxes over multiple years, but we'll explain one simple trick to help minimize the total amount an individual has to pay.

Income Tax in the United States:

For the sake of keeping Ulmer Scientific a blog and not a book, we examine raw income tax only (exclusive of any credits, dividends, capital gains, etc.) for the single filer.

The United States uses a marginal tax rate to generate an average progressive, or effective tax rate, on one's income.  Plotting this rate against income generates this neat bunny-hop chart:

 Take special note of the tax bracket ranges and resulting effective tax rate.  Because of the marginal way taxes are calculated, individuals in the 28% tax bracket actually pay almost 3 percentage points less in total tax.  In theory, individuals could earn an infinite amount of income, and never fully pay the maximum rate of 35.6%.

Okay, so effective tax rates are cool, but most individuals would just like to know what that means in dollars.  Below are the total income tax owed and resulting take home pay for 95% (<$100,000/yr) of Americans:

2013 Estimated Tax & Take-Home Income for Single Filers
Notice the plot for Take Home Income After Tax never goes down as income increases.  In no way could earning more money in a year result in an individual taking home less money.

Now, fear of the "next tax bracket" isn't completely misplaced, income in the next bracket is taxed at a higher rate.  Having one's income break into the next bracket is never a bad thing, however if it can be avoided there is a way to save more and pay less in the long run.

The Trick:

To pay the least amount in total tax, earn the lowest average income over multiple years.

For example, say Sally Smith knows she'll earn $24k this year, $34k next year, and $44k the next year.  If she has a $10k bonus, it would be wisest to take it this year.  Taking it next year would result her in bonus being taxed at a higher rate ($775 more).  Taking it the third year would force a loss of an additional $225!

In conclusion, its not possible to earn less money in a year by crossing into the next tax bracket (Myth Busted); albeit, if an individual has a varying income, it makes sense to spread that income evenly over multiple years.

2 comments:

  1. There is a HUGE wealth gap from the top 2% to the 3% and this information is misinformed and ignorant. The entire working class of America receives around 3% of the wealth, while ONE RICH family receives MORE THAN 30% OF AMERICAS WEALTH! Corporations like GE DIDN'T PAY ANY TAXES ON OVER $100 BILLION! That's more tax than the working class creates. Centralized banking is the problem, which is why our forefathers who created this country had WAR on centralized banking. This country went to shit 2013 tax brackets.

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  2. Your figures are in error. The taxes for both Clinton and Bush were calculated using the maximum rate for that selected income. For instance the Clinton 1999 tax rate on 30K was 28%, which is what they used to get the 8400 figure. However taxes are not calculated that way. The first 25K of income would have been 2013 tax brackets at the lower 15% bracket first, thus yielding a much lower figure than what you show.I am not arguing that Bush doesn't have lower taxes. He certainly does. Of course he obtained his lower tax brackets by using deficit spending and increasing the national debt. Add back in the interest payments we'll be making and I bet Bush actually cost taxpayers far more than Clinton ever did.

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