Sunday, August 19, 2012

One More Word on Marginal Tax Rates

Down below, there seems to be some confusion about who pays what in income taxes.

There are some members (at least I think they're members) who have it in their noggins that if you make a quarter million per year, the horrid Obama Administration plans to slap an almost forty percent tax on your earnings.

... So you're admitting that a household with TWO incomes that combines to amount to over $250,000....

Will pay 40% in Federal incomes tax? ...

But Little Me admits nothing of the kind ...

What I write is:

... Let's say you're one of the fortunate few who earns, say, $290,000 in animation. If Obama's horrid marginal rates go through, that means:

1) You will pay the BUSH RATES on $001 to $250,000

2) You will pay 39.5% (extra 4.5%) on $250,001 to $290,000.

See, there's this amazing concept, in practice across the Fruited Plain for almost a century now, called The Progressive Income Tax. And that tax calls for your first X thousands of dollars to be paid at the bottom rate (in the present case, 0%) then the next X thousands of dollars to be paid at the next highest rate, and so on right up the wage ladder.

You know, Progressive.

But it gets even better. People get taxed on their adjusted gross earnings, which means income after tax payers have taken the usual middle class deductions, like interest on home loans and the deferral of taxes in 401(k) Plans.

Apparently its hard for folks to get their hands around the way the tax regs actually work, so charlatans can get people to believe that if they're ten bucks over the quarter million dollar line, then ka-BOOM! The whole nut is taxed at 39.5%.

That is, if the higher 39.5% rate gets put in after the start of the new year. But as Celshader says:

... Few Americans comprehend how our progressive tax system works. My co-workers are always surprised to learn that traditional IRA and 401(k) contributions can lower their tax bracket, because those contributions come from their most highly taxed dollars.

A family earning exactly $250,000/year will never see President Obama's 4.5% tax increase. A family earning $250,001/year might miss the extra 4.5 cents on that one dollar that they earned above $250,000, but I doubt it. ...

Education. It's a wonderful thing.


Celshader said...

Thank you for posting this. An understanding of the American progressive tax system is critical for tax-savvy investing.

For those interested, The Finance Buff also just posted a new article today about the effects of current law on the 2013 tax brackets.

Kevin Koch said...

Jennifer, your first link (from The Finance Buff website) is fantastic! What a straightforward illustration of marginal tax rates, with a bonus of demystifying traditional vs. roth 401ks (which applies equally well to IRAs). Everyone should read and reread that article until they completely understand it.

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