Not understanding simple tax brackets....

[MDM]

If I make $200k do I have to pay the 15% on all of it or just the first ~$120k?

If I have a regular W2 job making say $150k and then do consulting on the side, do I have to pay any SE tax? Or does being taxed on my $150k income satisfy that?

You pay 12.4% for SS up to the SS limit but no more.  You pay 2.9% for medicare on "everything."  See http://www.irs.gov/pub/irs-pdf/f1040sse.pdf.

Then there is the Additional Medicare Tax if you make that much: http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Questions-and-Answers-for-the-Additional-Medicare-Tax

[Mississippi Mudstache]

I had to explain this concept to my brother a few months ago, but the situation was reversed from the one described in the OP. He and his wife are expecting their second child, and he was trying to figure out what the impact would be on their take-home pay if she stayed home for a few years. He was under the impression that the loss of her income would be partially offset by a windfall of tax savings. He assumed that dropping from the 25% bracket to the 15% bracket would simply mean multiplying out the total income by the respective marginal rates. Needless to say, he was actually disappointed to find that it wasn't the case. I offered to review their finances and try to help figure out what the precise impact would be, but he never got things together for me to review.

Is it really so hard to find your last 1040 and look up the line that says "tax'? There's a good upper limit right there.

Really, I think most people only know/care how much they get back, and haven't the slightest clue how much they paid in.

[Neustache]

I had to explain this concept to my brother a few months ago, but the situation was reversed from the one described in the OP. He and his wife are expecting their second child, and he was trying to figure out what the impact would be on their take-home pay if she stayed home for a few years. He was under the impression that the loss of her income would be partially offset by a windfall of tax savings. He assumed that dropping from the 25% bracket to the 15% bracket would simply mean multiplying out the total income by the respective marginal rates. Needless to say, he was actually disappointed to find that it wasn't the case. I offered to review their finances and try to help figure out what the precise impact would be, but he never got things together for me to review.

Is it really so hard to find your last 1040 and look up the line that says "tax'? There's a good upper limit right there.

Really, I think most people only know/care how much they get back, and haven't the slightest clue how much they paid in.

^^Yep.  That's my understanding.  We have a very smart IT friend who was convinced if his wife worked they'd be bumped up into the next tax bracket.  We have flat taxes for city and state, so he must have meant federal.  I tried educating him...not sure he understood. 

[Dollar Slice]

And you can cut it by even more with a solo 401k.

I would love to do that since I don't have a 401k at work, but my income from freelancing this year is probably going to be $1500 or something similarly small. Not sure it's worth the paperwork and fees and etc. Hmm.

[CCCA]

Thanks, so LT Capital Gains are sort of like the last things to be taxed after everything else that's subject to normal tax brackets? 

That is a reasonable way to look at it.  The details are in the "Qualified Dividends and Capital Gain Tax Worksheet" - see the instructions for line 44 in http://www.irs.gov/pub/irs-pdf/i1040gi.pdf.

http://www.thetaxadviser.com/issues/2014/oct/tax-clinic-04.html has some good explanations.  You could create a small spreadsheet to ensure you understand.  If you do, see cells K3 and below in the case study spreadsheet for an example (or start from scratch!).

MDM, Thanks for the details.  Very helpful.

For MFJ with 2 exemptions, standard deduction, and no other income or deductions:
  Ordinary Income = $90,600 and LTCG = $10,000 gives federal tax in 2015 = $10,343
  Ordinary Income = $90,700 and LTCG = $10,000 gives federal tax in 2015 = $10,373

The $100 extra ordinary income increased the tax by $30, or 30%.

To elaborate on "why":
1) The extra $100 of ordinary income lands in the 15% bracket, and
2) That also pushes $100 of LTCG out of its 0% bracket and into the LTCG 15% bracket
...causing a tax increase of $100 * 15% + $100 * 15% = $100 * (15% + 15%) = $100 * 30% = $30.

This was very interesting!  But I guess it mainly applies to a window where your LTCG straddles the boundary between two different tax brackets.  I guess it would also apply at the boundary between the 15 and 20% LTCG brackets but not as dramatically since it only adds an additional 5% of taxes (35% to 40%) instead of doubling them (15% to 30%).  Plus, I'm never getting to that point since the income levels are so high.

[FrugalToque]

In Ontario, there was for one year an actual "tax" that worked like this.  It was called a "Health Care Levy*" 

It was something like:
income under $30k - $0
income under $45k - $150
income under $60k - $300

I'm making up the numbers, but you get the idea.  When you made the step from $29 999 to $30 000, your take home went down $149.  They fixed it the next year, phasing in each level of the levy.

But, yes, that fucking annoys me.  Right up there with "Sure I run a balance on my credit card, but it's okay ... I never pay any interest because I always pay that minimum balance!"  Faaaaaaaaaaaaa.

Toque.

* - Levy!  Technically not a "tax".

[Dollar Slice]

I would urge you to do it. The paperwork takes like 20 minutes and the Vanguard fee is $25/yr, less if you have a bunch invested with them. I did one to shelter about that amount, actually.

Really? Hmmm. I have all my money with Vanguard already. Do I have to incorporate or anything complicated like that? I.e. if someone was doing something super-simple, like babysitting, could they throw it in a solo 401k? Or do you have to be a legal business entity...?

[zephyr911]

Really, I think most people only know/care how much they get back, and haven't the slightest clue how much they paid in.

^^Yep.  That's my understanding.  We have a very smart IT friend who was convinced if his wife worked they'd be bumped up into the next tax bracket.  We have flat taxes for city and state, so he must have meant federal.  I tried educating him...not sure he understood.

Yep. Some days I wish I knew less about taxes so I could stop headasploding every time a layman opens their mouth... and I'm really just a low-level hack.

[Dollar Slice]

No need to incorporate, but you need to get an EIN, which takes like 2 seconds on the IRS website. I was doing one for my super simple freelance clerical work, and if I had babysitting income to declare, I'd throw that in there too. If you have already maxed the employee portion of a 401k, you can skip the whole solo 401k thing and just open a SEP-IRA for the employer portion, which takes like 2 seconds.

OH, one other thing. You MUST have the solo 401k account ESTABLISHED by the end of the calendar year in which you want to contribute. You can't wait until April 15, though you can wait until then to fund it for 2014.

Thanks so much for the info! I might come up with more questions but I'll post something in the Tax forum so I don't derail this thread further...

[Joel]

And in this instance, you technically have a 30% marginal tax rate on ordinary income.

Yes indeed.  Makes traditional 401k or IRA contributions that much more attractive in this situation.

How did you get to 30%?

MDM nailed the explanation on this:

For MFJ with 2 exemptions, standard deduction, and no other income or deductions:
  Ordinary Income = $90,600 and LTCG = $10,000 gives federal tax in 2015 = $10,343
  Ordinary Income = $90,700 and LTCG = $10,000 gives federal tax in 2015 = $10,373

The $100 extra ordinary income increased the tax by $30, or 30%.

To elaborate on "why":
1) The extra $100 of ordinary income lands in the 15% bracket, and
2) That also pushes $100 of LTCG out of its 0% bracket and into the LTCG 15% bracket
...causing a tax increase of $100 * 15% + $100 * 15% = $100 * (15% + 15%) = $100 * 30% = $30.

As a result, the window with 401k investments of a married couple is pretty wide from $37,450 taxable income (+$36,000k 401k space for 2 = $73,450 in taxable income). Additionally, you could contribute up to $3,950 to traditional IRA before that deduction starts to be phased out, so at least $77,400 in taxable income (or $98k in gross income considering $12.6 standard deduction and $8k exemptions).

[OneDollarAtATime]

[/quote]
I've read a few articles that the $15/hr fast food wages that some cities instituted have had this effect: people working fast food jobs have since lost other benefits, and are netting less than when they made minimum wage. Thus making the $15/hr a hardship.
[/quote]

Right?!?  "Hey, look, $15 an hour means we get to work LESS and we still get the same perks that we had before!!  Yay!!"

I read the same thing -- if they keep their 'normal' hours at $15 then they lose SNAP or whatever other 'assistance' / programs they are on...which has more value than doubling their current wages.  Ridiculous. 

[nobodyspecial]

I read the same thing -- if they keep their 'normal' hours at $15 then they lose SNAP or whatever other 'assistance' / programs they are on...which has more value than doubling their current wages.  Ridiculous.

More ridiculous than a system where the employer pays them $9/hour and the government chips in another $10 in SNAP?
Why not just nationalize the fast food chain and have the government pay the worker $19/hour directly?

I can't imagine any other industry where the government subsidizes the majority of your major input cost.

[forummm]

I read the same thing -- if they keep their 'normal' hours at $15 then they lose SNAP or whatever other 'assistance' / programs they are on...which has more value than doubling their current wages.  Ridiculous.

More ridiculous than a system where the employer pays them $9/hour and the government chips in another $10 in SNAP?
Why not just nationalize the fast food chain and have the government pay the worker $19/hour directly?

I can't imagine any other industry where the government subsidizes the majority of your major input cost.

How does SNAP pay $10/hour? That is not consistent with my understanding of the program. SNAP is a program that provides a certain amount of money per time period (monthly I think) that you can spend on specific food items. And is not related to hours you work.

[nobodyspecial]

Sorry not familiar with American social services.
But the point remains that the majority of minimum wage employees receive government income assistance, effectively subsidizing the wage costs of those employers that pay the lowest salaries, thus distorting the market and giving them an advantage over other employers.
I thought you guys were free market capitalists?

[zephyr911]

Sorry not familiar with American social services.
But the point remains that the majority of minimum wage employees receive government income assistance, effectively subsidizing the wage costs of those employers that pay the lowest salaries, thus distorting the market and giving them an advantage over other employers.
I thought you guys were free market capitalists?

We're full of shit, is what we are. We've lost our collective minds. Not that I hate America or think we're all stupid, but we definitely have a lot of delusional madness going on right now.

[Dictionary Time]

It's definitely something that is highly individual because there are so many moving parts.  I would just print out extra 1040s and run some scenarios.  Between the savers credit, and the additional child credit, we always got back more than we paid when I stayed home with the kids.

if they are at the lower limit, they might be losing eitc or other subsidies.  At the higher end, they could be losing out on deductions.

It's not going to make staying home free or profitable,  but maybe it will reduce the cost enough that it seems worth it.

Apparently regular people don't enjoy the process of mocking up different scenarios on tax forms. Don't forget state too. Then you'll have a good take home estimate to plug into your hypothetical budget to see if it works.

Or maybe you could just quit and see what happens.

[wenchsenior]

I would urge you to do it. The paperwork takes like 20 minutes and the Vanguard fee is $25/yr, less if you have a bunch invested with them. I did one to shelter about that amount, actually.

Really? Hmmm. I have all my money with Vanguard already. Do I have to incorporate or anything complicated like that? I.e. if someone was doing something super-simple, like babysitting, could they throw it in a solo 401k? Or do you have to be a legal business entity...?

No need to incorporate, but you need to get an EIN, which takes like 2 seconds on the IRS website. I was doing one for my super simple freelance clerical work, and if I had babysitting income to declare, I'd throw that in there too. If you have already maxed the employee portion of a 401k, you can skip the whole solo 401k thing and just open a SEP-IRA for the employer portion, which takes like 2 seconds.

OH, one other thing. You MUST have the solo 401k account ESTABLISHED by the end of the calendar year in which you want to contribute. You can't wait until April 15, though you can wait until then to fund it for 2014.

I just want to thank you guys for discussing this. I have been wavering for a while between a solo 401k and a SEP IRA, and you just decided me. 401k it is! I got my EIN this morning! I also set up a Roth IRA.

AND I cracked 105 lbs in weight (very hard gainer here) for the first time in two years!

Essentially, this was a morning full of WIN.

[Tabitha]

Yeah, I had a long, shall we say, debate, with a co-worker in an effort to explain this one. The misconception that marginal rates apply to all income is extremely pervasive and difficult to reverse, even with some intelligent people.

Where does this come from?  I had to explain marginal tax rates to an otherwise intelligent coworker this week. I was surprised this was a revelation to her. She just kept returning to "brackets" like they were disconnected from each other.

I'm pretty sure I learned the concept in high school, if not the first time I did my own taxes.

[minority_finance_mo]

I wonder if anyone has ever declined a raise with the false belief that it would cause them to lose money net of taxes. I would pay good money to see the look on his/her manager's face!

[Jack]

I wonder if anyone has ever declined a raise with the false belief that it would cause them to lose money net of taxes. I would pay good money to see the look on his/her manager's face!

Sadly, the manager would probably just nod in agreement that it makes perfect sense.

The HR / accounting person who handles payroll should (hopefully!) be facepalming, though.

[tat96]

 However, I am aware of no circumstances in which earning more money results in less take-home pay. I'd be curious if anyone else has ever witnessed or empirically verified such a thing.
[/quote]

I believe this is called the "Marriage Penalty".  Unfortunately, many people do not understand it and I have heard a lot of the same arguments over the years that is better for only the "breadwinner" to work and the other person to do nothing.

https://en.wikipedia.org/wiki/Marriage_penalty

In this article it explains how the tax code can have some negative consequences for a married couple with incredibly high incomes.  For instance, if the wife makes $250K and the husband makes $40k you will probably not run into a problem.  If both the husband and wife make $400k each, married filing jointly can result in a higher tax burden.  Granted, if your combined annual income is $800k I can't believe too many people will shed tears that you are paying a little extra tax.  At any rate, they can just file MFS and be done with it.

Lastly, my personal pet peeve with people and taxes is most people I know do not understand the difference between a marginal tax rate and an effective tax rate or how the graduated structure works.  I have to endlessly explain to people that they are not paying 25% of their income in taxes.  They are only paying 25% once they hit that bracket and then after their refund are only paying about 10%-15% overall (many cases much less).

I don't think American has a taxation problem so much as a situation where the taxpayers do not understand how the system works.   Politicians of course will endlessly exploit this lack of knowledge....  Don't even get me started on how most Americans believe that corporate taxes are the highest in the world at 35% considering most companies don't pay anywhere near that rate or even pay income taxes!!