How the Tax System Works
The biggest expense you will ever have is taxes, which is a fortunate, but unfortunate cost. Most of you have probably already filed your 2008 taxes and now will not even speak the word “tax” until next year. While I understand your distaste for the process, this is exactly what you should not do; tax preparation is more important than the actual tax filing process. A little tax planning can put more money into your pocket and less money into the Federal Governments. In order to properly plan your taxes, it is important to understand how the tax system works.
In my opinion, there is one big misconception the general public has with our tax system and that is the tax bracket you are in, is the rate you are taxed on all of your earned money for the year. This is not the case. Our system is a progressive one where you slowly get taxed at a higher rate. This is why if you look at your end of the year tax payment, it will not equal the exact percent of your tax bracket, it will be lower.
Looking at the 2009 tax brackets, you will see that married couples filing jointly that make $16,700 or less are taxed at 10%. It’s easy to assume this doesn’t apply to you because your income is far above $16,700. This is not the case because the first $16,700 you make is taxed at 10% and any money made over this amount is then taxed in the next bracket, which is 15%.
Let’s say that you and your spouse will make $70,000 in 2009 (keep in mind you likely made well over $70,000, but this is the amount after deductions) The first $16,700 you made will be taxed at 10%. Now, the amount from $16,700-$67,900 will be taxed at 15% and the remaining $2,100 would be taxed at 25%. Therefore, do not ever be afraid of making more money, because going into a higher tax bracket only affects the amount that actually falls into that bracket, not your entire year’s earnings.
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Comments
Good explanation. Definitely something that isn’t common knowledge. That’s why tax advantaged retirement accounts (ira, 401k) are such a good idea. They keep the top tiers of your income from the highest rates.
After I read this article, I went grab my paycheck stub from the first week in January and the last one I received in December of last year. Take home pay for both of them were the same amount; and during the year, I jumped through three different tax brackets.
Could you elaborate on this? If I read your article correctly, this should not be so.
Thanx for the service you do sir! Much appreciated!
Not to worry, your paychecks are withholding the correct amount. Your employer reports what your yearly earnings are estimated at, which helps figure a monthly average to deduct. This way your checks are not varied wildly month to month.
Good explanation and helpful chart. Taxes are a necessary evil, so you may as well get familiar with the process.
Nice work…