One of my old tax posts received a comment about how taxes are calculated using tax brackets so here goes:
First off, here’s a look at the 2007 tax brackets:
Married Filing Jointly |
||
TAX |
2007 TAXABLE |
2006 TAXABLE |
10% |
Not over $15,650 |
Not over $15,100 |
15 |
15,650 – 63,700 |
15,100 – 61,300 |
25 |
63,700 – 128,500 |
61,300 – 123,700 |
28 |
128,500 – 195,850 |
123,700 – 188,450 |
33 |
195,850 – 349,700 |
188,450 – 336,550 |
35 |
Over $349,700 |
Over $336,550 |
The reader asked how to calculate taxes on $349,700.
First a little clarification. There seems to be a misunderstanding about tax brackets. When you read something that says someone is in the 28% tax bracket, it doesn’t mean they pay taxes of 28% on all their income. Instead, they pay a 10% tax on the first $15,650 of their income, 15% tax on the next $48,050, 25% tax on the next $64,800. Only the income between $128,501 and $195,850 is actually taxed at 28%.
Now that we have that straight, let’s look at how taxes are calculated for someone who has a taxable income of $349,700. We’ll have to assume that they aren’t subject to the AMT. Here’s how the math works out:
So, although this family is in the 35% tax bracket, their actual tax (again, assuming they aren’t subject to the AMT) is 27.05%. So, when the government widens the lower income tax brackets, it also helps those in the higher brackets.
I hope this answers the reader’s question.
For more on taxes, check out these posts:
Tax Stuff You Need to Keep In Your Records
50 of the Most Easily Overlooked Tax Deductions
2007 Federal Income Tax Brackets
401(k) Contribution Limits for 2007
What is Modified Adjusted Gross Income?
Tax Links: Online Tax Resources
Awesome post. I admit I’m not the most knowledgeable when it come to taxes. I would normally assumed a 28% tax rate as well if someone said that to me. Thanks for the post.
And for those of us not fortunate enough – at least taxwise – to be Texicans, you’ll have to add your state taxes as well as the federal taxes, and potentially deduct them from your federal taxes if applicable.
One other item: if this is a windfall of some kind, the person may want to talk with a tax lawyer about how to receive it.
I can’t tell you what it was like to explain this in an undergraduate Economics class at a technical college. It was shear amazement, they had no idea whatsoever that it was done that way. Still, half the class missed the simple calculation on the quiz.
Accountants have their own formula for estimating a client’s effective tax rate based on their marginal tax rate.
It’s called the Rule of 8.
You simply take the marginal tax rate of the client (35%) and subtract 8 for your effective tax rate (27%). It’s just a rule of thumb but for the general population it works quite well even with deductions.
Great post. I have was always been confused by the tax table and now it all makes a lot more sense.
Don’t forget that that just covers federal income tax — most of us will also be paying medicare, social security, state taxes… plus capital gains taxes on investments.
Oh wow..I never knew how taxes were calculated either. I tried figuring it out multiple times and my numbers never came out right. Now I know.
The rule of 8 is cool too. Thanks for posting this.
I’m here from GetRichSlowly.
Just a quick reminder: you calculate taxes only on your taxable income. So if you start from your gross income, first subtract your deductions (e.g. the standard deduction for married filing jointly of $10,700) and exemptions (e.g. 2 x $3400 for a married couple) to get to your taxable income. Then calculate your taxes on that amount.
I’m so dumb when it comes to taxes but this was straight and to the point, great post!
very nicely laid out. Of course, it would be even easier if we had a flat tax. Oh well.