"HW "Skip" Weldon" <skip5700removethis[at]hotmail.com> wrote in message
news:anarh0lii12pd59tpcupp84278q14718ed[at]4ax.com...
- quote -

I have this conversation with clients way too often <g> . The two biggest
problems I see regarding this issue are 1) people simply do not understand
the difference between marginal tax brackets and effective tax rates; and 2)
some people are so dead set against paying taxes that they would rather
climb a tree to spend $1,000 to save $280 in tax rather than stand on the
ground, pay the tax and walk off with $720.

Let's talk about tax brackets and tax rates - while anyone filing a Married
Filing Joint Federal tax return with $64,000 in taxable income is in the 25%
marginal tax bracket, in actuality they only pay about 15% total in Federal
taxes. This is because of the tax brackets - from $0 to $14,000 the tax
bracket is 10%, from $14,001 to $56,800 the tax bracket is 15%, and from
$56,801 to $114,650 so the tax calculation works like this:
First $14K - tax is $700
$14K to $56,800 (next $42,801) - tax is $7,120
$56,801 to $64,000 (last $7,199) - tax is $1,800
Total Tax is $9,620
Yet if we consider that taxes of $9,620 were paid on $64,000 of taxable
income we get an effective rate of 15.031%.

One of the issues here is that no one can assign a tax bracket to the source
of a particular dollar amount, instead the marginal brackets are applied
against total taxable income. So if you have wages of $56,800 and interest
income of $7,200 we can't say that you are paying 25% tax on the interest
even though you are paying 25% on $7,200 worth of income.

The moral here is that you need to not get hung up in what the source of the
income is when calculating your total tax burden. For example, using the
above example, many folks will say they paid 25% tax on their interest
income, which is clearly not correct even though they did pay 25% on some of
their income. However, overall they still only paid about 15% total tax on
all of their income.

Now consider that you put $5,400 more in your pocket than if you had not had
that extra $7,200 in income. Is it worth $1,800 to put $5,400 in your
pocket? To answer this you have to consider what the value of your time is.
I remember hearing once that Bill Gates made so much money with Microsoft
that if he stopped to pick up a $100 bill lying on the sidewalk it would
cost him more than he could make if he were working. So for Bill, I'd guess
he'd leave the money - I wouldn't!

Lastly, many times a client will ask what they can do to reduce their
taxes - and I always tell them "reducing taxes is NOT the goal, the goal is
to maximize AFTER-TAX cash in your pocket." Let's go back to the above
example - if you get to put $5,400 in your pocket after taxes how much does
it really matter what the tax bracket was for the gross money?

Good luck,
Gene E. Utterback, EA

HW "Skip" Weldon wrote:
- quote -

DZ,
I know you said not to focus on the #'s but...first point is, keep in
mind that all tax brackets are based on TAXABLE income, not GROSS
income. So with the #s above you wouldn't be nearing the "89k" bracket
yet, because you need to subtract your deductions and exemptions (and
perhaps IRA or 401k plan contributions and who knows what else) from the
$88k gross income. Flip over last year's tax return (or look at on your
desk it if you're filing it today on an extension!) and check line 40 -
that's your "taxable income." That's what determines what bracket you're in.

Also, 89k is the married filing separately bracket, so if you file
jointly you have even more wiggle room...the MFJ break is at about 117k.

But for the basic point - as John said, when you hit another tax bracket
the higher tax rate doesn't apply to ALL of your income, just to the
income that falls in that bracket. So focusing just on the bracket
issue, as you keep earning extra dollars, you do end up taking home more
money, and there isn't necessarily an incentive to avoid getting to the
next bracket. It's just that the gov't gets a slightly larger share of
the "next dollar earned" as your income gets higher.

Sometimes you might want to shift income forward to the next year
because of the bracket issue, if that's in your control. For a lot of
people it isn't but sometimes you can control it, or your income varies
a lot year to year and you can figure out these bracket things to your
benefit. Like, if you itemize deductions you may be able to make state
income tax or property tax payments in December, or delay them until
January, depending on when you want the deduction to land.

-Tad

John A. Weeks III wrote:

- quote -

Some clients are quite "bracket sensitive" when making IRA/401K
contributions. For example, they limit their contribution to
amounts that will be offset at HIGHER than the 15% bracket. Once
they drop down to the 15% bracket, they no longer see the
advantage to such expenditures.

MTW

In article <anarh0lii12pd59tpcupp84278q14718ed[at]4ax.com> , HW \"Skip\"
Weldon <skip5700removethis[at]hotmail.com> wrote:

- quote -

There is one critical piece of information that the poster is
missing...tax rates are "marginal rates".

For example, the poster is assuming that if you make $89K, you
might be taxed at 10% ($8,900 in taxes), but if you make $91K,
you might be taxed at 15% ($13,600 in taxes). In this case,
the extra $2,000 in income resulted in $4,700 in additional
taxes--clearly not a good deal for the income earner.

The way it really works is that you pay the rate for a
given bracket, and any money you make over that bracket is
taxed at the higher rate for that bracket. Hard to say, but
easy to demonstrate.

Assume the tax brackets are 0% for 0-25K, 10% for 25K to 90K,
and 15% for 90K and over.

Our $89K earner would pay no tax for the first $25K, then pay
$6400 for the amount from $25K to $89K, for a grand total of
$6,400 in taxes.

Our $91K earner would pay no tax for the first $25K, then pay
$6500 for the amount from $25K to $90K, then pay 15% on the
last $1000 of income ($150), for a total of $6650 in taxes.

The extra $2000 in income only raises the tax bill by $250.

It always makes sense to minimize income when possible by
contributing to qualified retirement plans and other deductions
(where allowed), but not for the purposes of changing to a
different tax bracket. The brackets are fair and do not
punish you for earning more money. When you hear someone say
that they don't want to work overtime because the IRS will
just take it all away, then you know that you are talking with
someone who simply doesn't understand the system.

-john-

--
================================================== ==================
John A. Weeks III 952-432-2708 john[at]johnweeks.com
Newave Communications http://www.johnweeks.com
================================================== ==================

The following was cross-posted. With corrected headers, it is copied
below.

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Subject: Taxes - Trim Income Before Year-End?
From: "dizzy" <dz[at]keepacleaninbox.net
I was recently trying to figure out what "tax bracket" I'm in, and I'm
afraid I may be very near one of the dividing lines. Please consider
the following (if the tax code numbers are a little off, just adjust
everything accordingly -- the concept I'm trying to understand is
still the same):

Married filing jointly.

Wife makes $46,000. Husband makes $42,000. Total: $88,000.

Each may also make some bonus of a thousand or so, which would put
them at, say, $90,000.

If the cutoff between one tax rate and a higher tax rate is $89,000,
it seems like it might make sense to dump some taxable income before
the end of the year. (Just out of curiosity, does anyone know what
the difference in actual dollars would be between someone $1,000 under
the line and someone $1,000 over the line for each of the brackets?
Might be interesting to see how much that extra thousand bucks could
cost you.)

The couple can increase 401k contributions by a little bit. Would
opening a personal IRA also help them get under the limit? Are there
any other tax exempt vehicles that might help them squeeze through to
the lower rate?

Thanks.


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-HW "Skip" Weldon
Columbia, SC