Author Topic: Not understanding simple tax brackets....  (Read 14604 times)

TheAnonOne

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Not understanding simple tax brackets....
« on: August 12, 2015, 12:53:10 PM »
I was talking to a guy about his stay at home wife and how, "I am just under the next bracket, so if she works we will lose money!"

I attempted to explain that this simply isn't how it works, he couldn't comprehend that he had been wrong for 40 years of his existence.

For some reason, this particular item bugs me a lot. It probably has something to do with how much people complain about taxes, without even understanding them....


Any other stories about this topic?

zephyr911

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Re: Not understanding simple tax brackets....
« Reply #1 on: August 12, 2015, 01:01:04 PM »
I was talking to a guy about his stay at home wife and how, "I am just under the next bracket, so if she works we will lose money!"

I attempted to explain that this simply isn't how it works, he couldn't comprehend that he had been wrong for 40 years of his existence.

For some reason, this particular item bugs me a lot. It probably has something to do with how much people complain about taxes, without even understanding them....


Any other stories about this topic?
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.

I ended up having to actually pull up the tax tables and show him that, regardless of your income, the first increment of income is taxed at the lowest rate, and on up the scale. That finally got the point across.

The simpler way (which I tried first, but which didn't quite drive it home) is to simply show someone that on the tax tables, once you get above the first tax bracket, the amount due is NOT the same as just multiplying the marginal rate by the taxable income. It is less because you're taxed less on the portion of your income below your top bracket.

forummm

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Re: Not understanding simple tax brackets....
« Reply #2 on: August 12, 2015, 01:18:36 PM »
Yes, very common. We even get people on the forum that don't understand that.

nobodyspecial

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Re: Not understanding simple tax brackets....
« Reply #3 on: August 12, 2015, 01:24:42 PM »
It does apply to some taxes.
In a lot of europe the rate of the transfer tax when you sell a home is goes up with price, but it applies to the full price. So house prices stick at just under each of the tax bands. Or you have weird deals where the house is sold for $x99,000 and the curtains are sold separately for $50,000.


zephyr911

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Re: Not understanding simple tax brackets....
« Reply #4 on: August 12, 2015, 01:41:44 PM »
It does apply to some taxes.
In a lot of europe the rate of the transfer tax when you sell a home is goes up with price, but it applies to the full price. So house prices stick at just under each of the tax bands. Or you have weird deals where the house is sold for $x99,000 and the curtains are sold separately for $50,000.
That is downright comical. It also illustrates why taxes shouldn't be structured like that - because it breeds massively irrational behavior.

Within the context of personal income taxes in the U.S.A., even though personal income tax due never increases faster than personal income, there are non-linear effects such as the phaseouts in various deductions, and the dreaded AMT, that can produce rapidly diminishing returns as high income gets higher.

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.

Mississippi Mudstache

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Re: Not understanding simple tax brackets....
« Reply #5 on: August 12, 2015, 01:48:25 PM »
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.

zephyr911

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Re: Not understanding simple tax brackets....
« Reply #6 on: August 12, 2015, 01:49:23 PM »
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.

beltim

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Re: Not understanding simple tax brackets....
« Reply #7 on: August 12, 2015, 02:00:09 PM »
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.
I think you can also end up with seriously negative income tax rates, particularly if you are older (because higher insurance premia) if you earn an additional dollar over the limit for AC subsidies.

Losing out on ACA subsidies is one of two cases I know of where earning an extra $1 can result in a higher tax bill (and thus marginal rates of >100%, not negative as serpentstooth said).  The other is if you're just over the Saver's tax credit threshold, since there's no phaseout.

Dollar Slice

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Re: Not understanding simple tax brackets....
« Reply #8 on: August 12, 2015, 02:02:25 PM »
Not exactly the same thing, but this reminds me of a conversation I had on Facebook last year - I had gotten an offer from my boss of taking either a bonus or a raise (same amount). Now, the rational answer is to take the raise because it's forever and not a one-time deal. But humans are irrational, and my boss doubly so, and I thought it was a fair bet that if I took the bonus I would get the raise within 6-12 months anyway. So I posted on FB as a conundrum to get advice, and half of my friends said: take the bonus because money now is better than money later. The other half said: take the raise, because bonuses are taxed really high!

I tried really hard to explain that bonuses are taxed at the same rate as the rest of your salary (although the withholding may be different depending on what tax bracket you are in - for me it worked out perfect because bonuses are withheld at 25% and I was in the 25% bracket) but I don't think a single one of them was truly convinced that there was not some magic extra tax that you get slapped with on bonuses.

nobodyspecial

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Re: Not understanding simple tax brackets....
« Reply #9 on: August 12, 2015, 02:18:22 PM »
Quote
Maybe there's some exotic tax credit that can result in a negative income tax? Can you be eligible for the saver's credit and EITC at the same time? That might do it, but only because government benefits come into play.
Yes for a lot of poor people, you are forced to take a job or lose unemployment benefit. 
But the amount you are paid is less than all the other benefits you are going to lose now you are working. So together with the cost of working uniform/commute/meals you end up a lot poorer

zephyr911

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Re: Not understanding simple tax brackets....
« Reply #10 on: August 12, 2015, 02:19:39 PM »
Losing out on ACA subsidies is one of two cases I know of where earning an extra $1 can result in a higher tax bill (and thus marginal rates of >100%, not negative as serpentstooth said).  The other is if you're just over the Saver's tax credit threshold, since there's no phaseout.
Yeah, would not surprise me. I haven't been a paid tax preparer since before ACA implementation.

When you say saver's tax credit, do you mean the Retirement Savings Contribution Credit? Not being pedantic, just making sure I know exactly what you mean. I'm guessing the gentleman in question is unfamiliar with that, regardless... ;)

zephyr911

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Re: Not understanding simple tax brackets....
« Reply #11 on: August 12, 2015, 02:20:04 PM »
Yes for a lot of poor people, you are forced to take a job or lose unemployment benefit. 
But the amount you are paid is less than all the other benefits you are going to lose now you are working. So together with the cost of working uniform/commute/meals you end up a lot poorer
Not to quibble, but that isn't a tax.

forummm

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Re: Not understanding simple tax brackets....
« Reply #12 on: August 12, 2015, 02:21:16 PM »
Not exactly the same thing, but this reminds me of a conversation I had on Facebook last year - I had gotten an offer from my boss of taking either a bonus or a raise (same amount). Now, the rational answer is to take the raise because it's forever and not a one-time deal. But humans are irrational, and my boss doubly so, and I thought it was a fair bet that if I took the bonus I would get the raise within 6-12 months anyway. So I posted on FB as a conundrum to get advice, and half of my friends said: take the bonus because money now is better than money later. The other half said: take the raise, because bonuses are taxed really high!

I tried really hard to explain that bonuses are taxed at the same rate as the rest of your salary (although the withholding may be different depending on what tax bracket you are in - for me it worked out perfect because bonuses are withheld at 25% and I was in the 25% bracket) but I don't think a single one of them was truly convinced that there was not some magic extra tax that you get slapped with on bonuses.

So you took the bonus? Did you get the raise too?

I'm a red panda

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Re: Not understanding simple tax brackets....
« Reply #13 on: August 12, 2015, 02:23:36 PM »
Quote
Maybe there's some exotic tax credit that can result in a negative income tax? Can you be eligible for the saver's credit and EITC at the same time? That might do it, but only because government benefits come into play.
Yes for a lot of poor people, you are forced to take a job or lose unemployment benefit. 
But the amount you are paid is less than all the other benefits you are going to lose now you are working. So together with the cost of working uniform/commute/meals you end up a lot poorer

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.

beltim

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Re: Not understanding simple tax brackets....
« Reply #14 on: August 12, 2015, 02:25:28 PM »
Losing out on ACA subsidies is one of two cases I know of where earning an extra $1 can result in a higher tax bill (and thus marginal rates of >100%, not negative as serpentstooth said).  The other is if you're just over the Saver's tax credit threshold, since there's no phaseout.
Yeah, would not surprise me. I haven't been a paid tax preparer since before ACA implementation.

When you say saver's tax credit, do you mean the Retirement Savings Contribution Credit? Not being pedantic, just making sure I know exactly what you mean. I'm guessing the gentleman in question is unfamiliar with that, regardless... ;)

Yes, I meant the Retirement Savings Contribution Credit.

nobodyspecial

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Re: Not understanding simple tax brackets....
« Reply #15 on: August 12, 2015, 02:28:31 PM »
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.
You don't have zero-hour contracts yet in fast food?
You are employed, typically at minimum wage, but with no defined hours of work.
The store calls you when it thinks it will be busy, you work and are paid for an hour and are then clocked-off to wait outside until the next busy period. Like Marlon Brando in On the Waterfront, but with lower pay and less certainty.

But it's necessary in a modern advanced economy because otherwise fast-food jobs would be off-shored to cheaper countries.





Dollar Slice

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Re: Not understanding simple tax brackets....
« Reply #16 on: August 12, 2015, 02:33:30 PM »
So you took the bonus? Did you get the raise too?
Took the bonus in August, had the raise by December :-) 

MgoSam

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Re: Not understanding simple tax brackets....
« Reply #17 on: August 12, 2015, 02:42:26 PM »
I remember a few years there was an article about people that wanted to keep their salary under $250k to avoid losing money. They thought that being at $249k would net them more money than if they earned $251k.

zephyr911

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Re: Not understanding simple tax brackets....
« Reply #18 on: August 12, 2015, 02:45:08 PM »
I remember a few years there was an article about people that wanted to keep their salary under $250k to avoid losing money. They thought that being at $249k would net them more money than if they earned $251k.
These stories are uber-sad when it's about doctors and lawyers who you'd assume know better.

KittyCat

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Re: Not understanding simple tax brackets....
« Reply #19 on: August 12, 2015, 03:05:26 PM »
I think that they are confusing lower income in terms of percentage of what they get to keep with lower income in terms of absolute dollars.

forummm

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Re: Not understanding simple tax brackets....
« Reply #20 on: August 12, 2015, 03:18:17 PM »
I remember a few years there was an article about people that wanted to keep their salary under $250k to avoid losing money. They thought that being at $249k would net them more money than if they earned $251k.
These stories are uber-sad when it's about doctors and lawyers who you'd assume know better.

There are a lot of idiots with MDs and JDs.

MgoSam

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Re: Not understanding simple tax brackets....
« Reply #21 on: August 12, 2015, 03:26:49 PM »
I remember a few years there was an article about people that wanted to keep their salary under $250k to avoid losing money. They thought that being at $249k would net them more money than if they earned $251k.
These stories are uber-sad when it's about doctors and lawyers who you'd assume know better.

There are a lot of idiots with MDs and JDs.

The part that gets me about this is that a simple google search would have helped them. Many of MD's and JD's have accountants that file their taxes, especially as they usually have a ton of things to itemize. You would think a simple, "Hey, if I earned ___, would I be better off than had I earned ___." I know there's a lot I don't know, and thankfully my uncle is an accountant and approachable, so I will ask him as often as I can.

Neustache

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Re: Not understanding simple tax brackets....
« Reply #22 on: August 12, 2015, 03:42:32 PM »
I used to think this about tax brackets....took doing my own to understand it. 

I was explaining to my dad that with their personal exemptions and deductions that they could earn X amount per year tax free (somewhere around 18K).  He replied he had no idea it worked that way.  He's a smart dude, business owner, etc. and is 66.  He just never bothered to learn about taxes.


forummm

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Re: Not understanding simple tax brackets....
« Reply #23 on: August 12, 2015, 04:15:57 PM »
My mom told me a story about how her friend made $600 doing a consumer products study but forgot to tell him until the W2 showed up in January. And then the friend's husband got all angry with the friend because he had worked his business income and deductions and had gotten them down into the lower bracket and this was going to cost them so much money because it bumped them back into the higher bracket. All 3 of those adults, including the business owner, didn't understand the tax code.

KittyCat

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Re: Not understanding simple tax brackets....
« Reply #24 on: August 12, 2015, 04:19:36 PM »
My mom told me a story about how her friend made $600 doing a consumer products study but forgot to tell him until the W2 showed up in January. And then the friend's husband got all angry with the friend because he had worked his business income and deductions and had gotten them down into the lower bracket and this was going to cost them so much money because it bumped them back into the higher bracket. All 3 of those adults, including the business owner, didn't understand the tax code.
Ouch, that sucks; I imagine that they would not have bothered playing around with tax-preparation software to see the what-if numbers either.

Jack

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Re: Not understanding simple tax brackets....
« Reply #25 on: August 12, 2015, 04:39:31 PM »
The other is if you're just over the Saver's tax credit threshold, since there's no phaseout.

The Saver's Credit does have a phaseout. It steps down from 50% to 20% to 10% to 0%. It's pretty jagged, but not totally vertical.

beltim

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Re: Not understanding simple tax brackets....
« Reply #26 on: August 12, 2015, 04:45:39 PM »
The other is if you're just over the Saver's tax credit threshold, since there's no phaseout.

The Saver's Credit does have a phaseout. It steps down from 50% to 20% to 10% to 0%. It's pretty jagged, but not totally vertical.

Technically right. I should have used the word "cliff" instead of phaseout.

Cathy

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Re: Not understanding simple tax brackets....
« Reply #27 on: August 12, 2015, 04:50:02 PM »
Losing out on ACA subsidies is one of two cases I know of where earning an extra $1 can result in a higher tax bill (and thus marginal rates of >100%, not negative as serpentstooth said).  The other is if you're just over the Saver's tax credit threshold, since there's no phaseout.

Another instance of this phenomenon is self-employment tax. If net earnings from self-employment are less than $400, then the self-employment tax is $0. But if the net earnings from self-employment are exactly $400, then self-employment tax is payable on the entire $400. See 26 USC 1401, 1402(b).

MDM

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Re: Not understanding simple tax brackets....
« Reply #28 on: August 12, 2015, 05:03:42 PM »
The other is if you're just over the Saver's tax credit threshold, since there's no phaseout.

A specific example of the above:

MFJ with $72,000 gross income, $36,000 contributed to traditional 401k: $    0 in federal tax.
MFJ with $72,001 gross income, $36,000 contributed to traditional 401k: $740 in federal tax.

Difference is due to the step decrease in the Saver's credit.

Hamster

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Re: Not understanding simple tax brackets....
« Reply #29 on: August 12, 2015, 05:51:30 PM »
I remember a few years there was an article about people that wanted to keep their salary under $250k to avoid losing money. They thought that being at $249k would net them more money than if they earned $251k.
These stories are uber-sad when it's about doctors and lawyers who you'd assume know better.

There are a lot of idiots with MDs and JDs.
Many of my doctor friends are clueless about taxes and personal finances - and hold the same misconceptions about bonuses being taxed highly. This was a big debate around our last compensation plan "We would rather have our production pay evened out over the whole year instead of trued up every 3 months because we don't want a big tax hit when we get quarterly incentive pay-outs"... smh...

I think idiots is a bit harsh, but a lot of people with a lot of education remain intentionally ignorant of how to manage their money and spending.

MgoSam

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Re: Not understanding simple tax brackets....
« Reply #30 on: August 12, 2015, 06:06:55 PM »
I remember a few years there was an article about people that wanted to keep their salary under $250k to avoid losing money. They thought that being at $249k would net them more money than if they earned $251k.
These stories are uber-sad when it's about doctors and lawyers who you'd assume know better.

There are a lot of idiots with MDs and JDs.
Many of my doctor friends are clueless about taxes and personal finances - and hold the same misconceptions about bonuses being taxed highly. This was a big debate around our last compensation plan "We would rather have our production pay evened out over the whole year instead of trued up every 3 months because we don't want a big tax hit when we get quarterly incentive pay-outs"... smh...

I think idiots is a bit harsh, but a lot of people with a lot of education remain intentionally ignorant of how to manage their money and spending.

Yeah, I can say this with certainty with many of the doctors and academics I have in my family. My uncle is brilliant when it comes to medicine, but crazy when it comes to his finances.

CCCA

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Re: Not understanding simple tax brackets....
« Reply #31 on: August 12, 2015, 06:19:35 PM »
since we are on the topic, one thing that I don't understand is how long-term capital gains is calculated. 
I know if I'm in the 15% marginal tax bracket or under LT capital gains are taxed at 0% and if I'm in the 25% to 35% brackets then LT capital gains are taxed at 15%. 


What I don't understand is whether they can also exhibit the same marginal tax behavior that ordinary income exhibits.
For married filing jointly (MFJ) the cutoff is $74900.  Let's say 70K of your income is ordinary wage income and 10k is LT capital gains.  Since you are over the $74.9k cutoff, is teh entirety of your 10k in LTcap gains taxed at 15% or is the first 4.9K taxed at 0% and the remainder taxed at 15%?




MDM

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Re: Not understanding simple tax brackets....
« Reply #32 on: August 12, 2015, 07:16:22 PM »
since we are on the topic, one thing that I don't understand is how long-term capital gains is calculated. 
I know if I'm in the 15% marginal tax bracket or under LT capital gains are taxed at 0% and if I'm in the 25% to 35% brackets then LT capital gains are taxed at 15%. 


What I don't understand is whether they can also exhibit the same marginal tax behavior that ordinary income exhibits.
For married filing jointly (MFJ) the cutoff is $74900.  Let's say 70K of your income is ordinary wage income and 10k is LT capital gains.  Since you are over the $74.9k cutoff, is teh entirety of your 10k in LTcap gains taxed at 15% or is the first 4.9K taxed at 0% and the remainder taxed at 15%?

Assuming your ordinary wage income is $70K + $12.6K (std. deduction) + $8K (exemptions) = $90.6K, so your taxable ordinary income is $70K: the first 4.9K of LTCG is taxed at 0% and the remainder taxed at 15.%

CCCA

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Re: Not understanding simple tax brackets....
« Reply #33 on: August 12, 2015, 09:14:44 PM »
since we are on the topic, one thing that I don't understand is how long-term capital gains is calculated. 
I know if I'm in the 15% marginal tax bracket or under LT capital gains are taxed at 0% and if I'm in the 25% to 35% brackets then LT capital gains are taxed at 15%. 


What I don't understand is whether they can also exhibit the same marginal tax behavior that ordinary income exhibits.
For married filing jointly (MFJ) the cutoff is $74900.  Let's say 70K of your income is ordinary wage income and 10k is LT capital gains.  Since you are over the $74.9k cutoff, is teh entirety of your 10k in LTcap gains taxed at 15% or is the first 4.9K taxed at 0% and the remainder taxed at 15%?

Assuming your ordinary wage income is $70K + $12.6K (std. deduction) + $8K (exemptions) = $90.6K, so your taxable ordinary income is $70K: the first 4.9K of LTCG is taxed at 0% and the remainder taxed at 15.%


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? 
And thanks for correcting my example which didn't take into account deductions/exemptions.


MDM

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Re: Not understanding simple tax brackets....
« Reply #34 on: August 12, 2015, 09:42:35 PM »
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!).

Joel

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Re: Not understanding simple tax brackets....
« Reply #35 on: August 12, 2015, 10:17:07 PM »
since we are on the topic, one thing that I don't understand is how long-term capital gains is calculated. 
I know if I'm in the 15% marginal tax bracket or under LT capital gains are taxed at 0% and if I'm in the 25% to 35% brackets then LT capital gains are taxed at 15%. 


What I don't understand is whether they can also exhibit the same marginal tax behavior that ordinary income exhibits.
For married filing jointly (MFJ) the cutoff is $74900.  Let's say 70K of your income is ordinary wage income and 10k is LT capital gains.  Since you are over the $74.9k cutoff, is teh entirety of your 10k in LTcap gains taxed at 15% or is the first 4.9K taxed at 0% and the remainder taxed at 15%?

Assuming your ordinary wage income is $70K + $12.6K (std. deduction) + $8K (exemptions) = $90.6K, so your taxable ordinary income is $70K: the first 4.9K of LTCG is taxed at 0% and the remainder taxed at 15.%

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

Cpa Cat

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Re: Not understanding simple tax brackets....
« Reply #36 on: August 12, 2015, 10:23:27 PM »
I think self-employment taxes bother me the most.

No one seems bothered by social security and medicare taxes when they're W-2 employees, but call it "self employment taxes" and put it on the tax return and OH MY GOD WHAT IS THIS TAX?!?!

I have a lot of clients who pay ONLY self employment tax and it's still "This tax is too high! How do I get out of it??" You don't! Pay your f-ing 15% quarterly like I tell you to!

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Re: Not understanding simple tax brackets....
« Reply #37 on: August 12, 2015, 10:33:16 PM »
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.

beltim

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Re: Not understanding simple tax brackets....
« Reply #38 on: August 12, 2015, 10:42:55 PM »
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

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Re: Not understanding simple tax brackets....
« Reply #39 on: August 12, 2015, 11:04:02 PM »
How did you get to 30%?

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%.

*These numbers may be off by a few dollars if you use the tax tables, but the difference between them should still be $30.

dfields

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Re: Not understanding simple tax brackets....
« Reply #40 on: August 12, 2015, 11:08:17 PM »
Here's a clip from The West Wing (a show that really should have known better) that always bugged me.

https://www.youtube.com/watch?v=J48-3aDwhIc

So not only is your marginal rate your effective rate, but there are also no standard deductions/exemptions.

MDM

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Re: Not understanding simple tax brackets....
« Reply #41 on: August 13, 2015, 12:04:25 AM »
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.

K-ice

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Re: Not understanding simple tax brackets....
« Reply #42 on: August 13, 2015, 12:06:22 AM »
I know someone who didn't understand tax brackets. It's quite easy. The more you make the more you will have as take home.

He also didn't want to earn more as he would have to pay more child support.

Winner!

I'm a red panda

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Re: Not understanding simple tax brackets....
« Reply #43 on: August 13, 2015, 07:10:41 AM »
I think self-employment taxes bother me the most.

No one seems bothered by social security and medicare taxes when they're W-2 employees, but call it "self employment taxes" and put it on the tax return and OH MY GOD WHAT IS THIS TAX?!?!

I think part of the problem is people forget the employer was paying that too. Self employment taxes are SO HIGH. Because you have to pay both sides of it.

People think "wow, I get $50 an hour" and think they will make bank; but don't realize that is basically the same as $25 an hour at an employer.  (At least that is how the numbers worked for me.)

Dollar Slice

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Re: Not understanding simple tax brackets....
« Reply #44 on: August 13, 2015, 07:32:04 AM »
I think self-employment taxes bother me the most.

No one seems bothered by social security and medicare taxes when they're W-2 employees, but call it "self employment taxes" and put it on the tax return and OH MY GOD WHAT IS THIS TAX?!?!
I understand why it exists and all, but it *is* a bit of a shock when I realize that any freelance income I have on top of my regular job is going to be taxed at a full 50% (15.3% SE tax, 25% federal, 6.45% state, 3.591% local = 50.341%). Very discouraging for the side hustles.

NorCal

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Re: Not understanding simple tax brackets....
« Reply #45 on: August 13, 2015, 07:36:02 AM »
I remember a few years there was an article about people that wanted to keep their salary under $250k to avoid losing money. They thought that being at $249k would net them more money than if they earned $251k.
These stories are uber-sad when it's about doctors and lawyers who you'd assume know better.

There is actually some merit to this one.  With the passage of Obamacare, there is now a 3.8% tax on ALL investment income if MAGI (married filing jointly) is above $250K.  So if you have significant earnings AND significant investment income (some high earners have this, some don't), the difference between making $249K and $251K is actually pretty significant.

If I remember correctly, there's also an earnings threshold below which dividends and capital gains are not taxed at all.  The difference between having an income just above or just below this threshold could be significant for those in early retirement. 

beltim

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Re: Not understanding simple tax brackets....
« Reply #46 on: August 13, 2015, 07:42:23 AM »
I remember a few years there was an article about people that wanted to keep their salary under $250k to avoid losing money. They thought that being at $249k would net them more money than if they earned $251k.
These stories are uber-sad when it's about doctors and lawyers who you'd assume know better.

There is actually some merit to this one.  With the passage of Obamacare, there is now a 3.8% tax on ALL investment income if MAGI (married filing jointly) is above $250K.  So if you have significant earnings AND significant investment income (some high earners have this, some don't), the difference between making $249K and $251K is actually pretty significant.

If I remember correctly, there's also an earnings threshold below which dividends and capital gains are not taxed at all.  The difference between having an income just above or just below this threshold could be significant for those in early retirement.

Wrong on both counts.

The 3.8% Medicare surcharge is based on the lesser of a) net investment income, or b) amount of MAGI above $250,000.  There's no way that additional dollars of income can result in less after-tax money because of this.  https://www.fidelity.com/viewpoints/personal-finance/new-medicare-taxes

Similarly, qualified dividends and long term capital gains are not taxed as long as the total income places the taxpayer in the 15% tax bracket or below, but only qualified dividends and long term capital gains above the 15% tax bracket is taxed.  So again, there's no way that additional dollars of income can result in less after-tax money because of this.

Cpa Cat

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Re: Not understanding simple tax brackets....
« Reply #47 on: August 13, 2015, 08:00:26 AM »
I think self-employment taxes bother me the most.

No one seems bothered by social security and medicare taxes when they're W-2 employees, but call it "self employment taxes" and put it on the tax return and OH MY GOD WHAT IS THIS TAX?!?!
I understand why it exists and all, but it *is* a bit of a shock when I realize that any freelance income I have on top of my regular job is going to be taxed at a full 50% (15.3% SE tax, 25% federal, 6.45% state, 3.591% local = 50.341%). Very discouraging for the side hustles.

That's not technically correct, since you get the deduction for half of the SE tax, against regular income tax. So the income tax portion (state and local, too, probably) is slightly less. Also - all of those taxes exist when you're a W-2 employee. When employers make decisions about hiring/raises. etc. they factor in their total costs - including their payroll taxes. It's all part of your "compensation" when they look at you.

Dollar Slice

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Re: Not understanding simple tax brackets....
« Reply #48 on: August 13, 2015, 09:21:03 AM »
That's not technically correct, since you get the deduction for half of the SE tax, against regular income tax. So the income tax portion (state and local, too, probably) is slightly less. Also - all of those taxes exist when you're a W-2 employee. When employers make decisions about hiring/raises. etc. they factor in their total costs - including their payroll taxes. It's all part of your "compensation" when they look at you.
Yes, I am aware of all that (I do payroll at the small biz I work at). It's not a 100% rational thought, but you just have that "I only get to keep HALF?!" moment when you're figuring it out. It's the payroll tax combined with the marginal tax (since you're adding this to W2 income) that just feels really high. I take home 66% of my paycheck even after health and dental insurance is deducted, so it seems like a huge difference in tax rates. Even though I do understand how the math works :-)

forummm

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Re: Not understanding simple tax brackets....
« Reply #49 on: August 13, 2015, 10:56:03 AM »
I think self-employment taxes bother me the most.

No one seems bothered by social security and medicare taxes when they're W-2 employees, but call it "self employment taxes" and put it on the tax return and OH MY GOD WHAT IS THIS TAX?!?!
I understand why it exists and all, but it *is* a bit of a shock when I realize that any freelance income I have on top of my regular job is going to be taxed at a full 50% (15.3% SE tax, 25% federal, 6.45% state, 3.591% local = 50.341%). Very discouraging for the side hustles.

That's not technically correct, since you get the deduction for half of the SE tax, against regular income tax. So the income tax portion (state and local, too, probably) is slightly less. Also - all of those taxes exist when you're a W-2 employee. When employers make decisions about hiring/raises. etc. they factor in their total costs - including their payroll taxes. It's all part of your "compensation" when they look at you.

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

Cpa Cat, does the SE tax cap out on the "employer" side once the SS limit is reached each year? 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?