Good morning & happy Monday!
“In this world, nothing is certain except death and taxes.”
– Benjamin Franklin, 1789
Well, tax day is upon us! I know you’re excited!😉
I thought today might be an opportune time to discuss how the tax system in the United States works. I can sense your excitement with this topic. (I think I just lost half my audience😉).
Just so we are clear, I am not a CPA and none of this discussion is to be considered tax advice. Full disclosure: I will always recommend seeking a tax professional for tax-related matters.
In the U.S. we have what is called a progressive tax code. The more income you make the higher the rate of taxes on the higher dollars. The first dollars you make are taxed at a lower rate, the later dollars you make are likely taxed at a higher rate. The examples below will explain this further.
Please see the attached guide for a comprehensive, in-depth look at some major tax issues. I reference this guide many times a week, hopefully you find it a valuable resource as well.
Taxes are determined based on marital status: you either filed a joint tax return with your spouse or a single tax return (married people can file as 2 single people, but usually that is not beneficial).
Single tax filers for 2023:
Standard deduction = $13,850
$0-$11,000 taxable income = 10% tax rate
$11,000 – $44,725 taxable income = 12% tax rate
$44,725 – $95,375 taxable income = 22% tax rate
$95,375 – $182,100 taxable income = 24% tax rate
$182,100 – $231,250 taxable income = 32% tax rate
$231,250 – $578,125 taxable income = 35% tax rate
Over $578,125 taxable income = 37% tax rate
Joint tax filers for 2023:
Standard deduction = $27,700
$0-$22,000 taxable income = 10% tax rate
$22,000 – $89,450 taxable income = 12% tax rate
$89,450 – $190,750 taxable income = 22% tax rate
$190,750 – $364,200 taxable income = 24% tax rate
$364,200 – $462,500 taxable income = 32% tax rate
$462,500 – $693,750 taxable income = 35% tax rate
Over $693,750 taxable income = 37% tax rate
Let’s take a look at a couple of examples of how this works to hopefully make sense out of all of this.
Let’s say a single person makes $100,000/year in income, here is how that is calculated:
The first $13,850 made is completely not taxable as that is the standard deduction. So we take $100,000 – $13,850 to get $86,150 of taxable income.
Then the next $11,000 is taxed at 10%.
Taxable income from $11,000 – $44,725 is taxed at 12%.
And then income from $44,725 – $95,375 is taxed at 22%.
In this example the individual had
- $13,850 taxed @ 0% (standard deduction) = $0 tax on those earnings
- $11,000 taxed @ 10% = $1,100 in tax on those earnings
- $33,750 ($44,725 – $11,000) taxed @ 12% = $4,050 in tax on those earnings
- This leaves $41,425 remaining to be taxed ($86,150 of taxable income – $44,725 top dollars in last tax bracket), that will be taxed @ 22% = $9,113.50 in tax on those earnings
- Total taxes = $14,263.50 ($1,100 + $4,050 + $9,113.50)
- This means that even though this individual tops out in the 22% tax bracket, their cumulative tax rate is 14.26% ($14,263.50 divided by $100,000).
Confusing? You bet. It’s the IRS way. 😉
Believe it or not we are only scratching the surface as there are all sorts of other components that come into play (child tax credit, long term capital gains treatment, Social Security taxation, self-employment taxes, alternative minimum tax, itemized deductions, above the line deductions, and various tax credits just to name a few). But I wanted to explain the basics here.
Let’s look at one more example just to drive the point home.
This time the scenario is a married couple filing a joint tax return with $100,000 of household income. (Same income as above, but now it’s a married couple as opposed to a single tax filer.)
The first $27,700 made is completely not taxable as that is the standard deduction. So, we take $100,000 – $27,700 to get $72,300 of taxable income.
Then the next $22,000 is taxed at 10%.
Taxable income from $22,000 – $89,450 is taxed at 12%.
In this example the couple had …
- $27,700 taxed @ 0% (standard deduction) = $0 tax on those earnings
- $22,000 taxed @ 10% = $2,200 in tax on those earnings
- Leaving $50,300 ($72,300 – $22,000) taxed @ 12% = $6,036 in tax on those earnings
- Total taxes = $8,236 ($2,200 + $6,036)
- This means that the couple’s cumulative tax rate is 8.24% ($8,236 divided by $100,000) even though they capped out at the 12% tax rate.
Does your head hurt yet? 😉
I know this is confusing stuff, but hopefully this conversation is helpful in understanding how taxes are calculated.
Please feel free to reach out if I can provide any clarification … or if you need an aspirin after reading this 😉
Make it a great week ahead!