So THIS Is How The Federal Tax Code ACTUALLY Works...

As we close in on a federal tax reform package that may be in place for 2018 - I continue to hear, see and read confusion from people on the topic of what exactly people pay. 

The tax code is complicated as can be. 

Being confused about how it works doesn't make you dumb, but it could cause you to make personal mistakes based on the code if you don't understand how it works. 

Here's the current tax code brackets (the layout via the Tax Foundation):  

2017 Tax rates for an individual's: 

  • 10 percent: $0 to $9,325 
  • 15 percent: $9,325 to $37,950 
  • 25 percent: $37,950 to $91,900 
  • 28 percent: $91,900 to $191,650 
  • 33 percent: $191,650 to $416,700 
  • 35 percent$416,700 to $418,400 
  • 39.60 percent: $418,400+ 

Those are the seven brackets you're hearing about potentially being reduced to three or four. 

So back to the confusion for a moment.... 

Let's say that you earn/report $40,000 this year. It doesn't mean that your tax rate is 25 percent on all money earned. 

Only $2,050 would be taxed at 25 percent, with the majority of your earnings being taxed at 15 percent. 

The most common mistake I see/hear/read is that people think whatever the bracket they end in with reported income is the bracket they have to pay for all income.

I'd be willing to bet most Americans think they pay more in federal taxes than they actually do. 

The average net effective tax rate for all individuals filing taxes in 2015 was 13.5 percent. How is it so low that given the tax rate is higher as soon as someone earns more than $9,325? Deductions. 

This next piece of info isn't the most recent data available on net effective tax rates but it's instructive. 

The Tax Foundation found in a 2012 study that the average net effective Federal Tax Rates were the following:  

  • -14 percent: Those who filed with $15,000 or less income 
  • -5 percent: For those with under $30k of income 
  • +3 percent: For those with under $50k 
  • +8 percent: Under $100k 
  • +13 percent Under $200k 
  • +22 percent: Under $1 million 
  • +23 percent Over $1 million 

Surprised? Tax rates are higher today compared to when this was done but it helps to paint the picture of who really ends up paying taxes, why the net effective tax rate is only around 13 pwercent and the enormous impact of deductions. In this 2012 example the average person earning $30,000 profited off-of the federal tax code by $1,500 and the average person earning a million would have paid about $230,000 in taxes. 

The one uniting trait is that both would tell you they probably paid too much in taxes. It's a similar but different story with business taxes. 

So, as we wait and watch what might be next on the tax front - a simpler code and process would go a long way towards helping people understand what's really going on and what they're really paying (or profiting) from in the code. 


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