A Bit About Taxes – Understanding Effective Tax Rates For 2007 – Planning For 2008
I will be the first to admit – I know very, very little about taxes. So, in an effort to learn a little bit more about ‘tax rates’, I did a search of the IRS website and I found this page –. (Please visit the IRS site for detailed information about your tax rate. I’ve provided a summary of the information provided for those who are Married – Filing Jointly. This summary is provided solely for the purpose of discussion, and you should consult with a qualified tax professional before making any tax-related decisions.)
Married – Filing Jointly
When most people talk about their taxes, they talk about their “tax bracket”. I have been thinking about my “tax bracket” – and since my wife and I earn between $63,000 and $128,500 – I assumed that I was in the 25% “tax bracket”. I was, as is often the case when it comes to stuff like this, wrong. Or, at least, I was “kinda” wrong.
See, my “tax bracket” is the percentage of tax that I pay on my “last dollar” I earn. In my case, that would put me in the 25% “tax bracket”.
So, if I want to figure my federal income taxes for the year, I just multiply my taxable income by .25 and, bingo, I know how much I’ll owe, right? In the words of Lee Corso, “Not so fast, my friend!”
The .25 is multiplied by the amount of taxable income that I earn ABOVE $63,700. Different rates are applied to the amount I earn BELOW $63,700.
Let’s assume, just for this example, that my wife and I had a taxable income of $70,000. (This, by the way, is not the time or place to discuss what “taxable income” is. See the bottom of this post.)
We would pay a 10% tax on the first $15,650 of our income. ($1,565)
We would pay a 15% tax on the next $48,050 of our income. ($7207.50)
We would pay a 25$ tax on the next $6,300 of our income. ($1575)
If our taxable income was $70,000, our total federal income taxes would be $10,347.50.
Our EFFECTIVE tax rate would be 14.78%.
Again, I will remind you that I know very, very little about taxes, but I think I have this right. Please, if you have corrections or observations, I’d love to read them. Leave a comment!
A few quick notes:
1. Taxable Income is (generally speaking) gross income minus deductions.
2. $70,000 is just a random number that I chose for my example.
3. One of my goals for 2008 will be to reduce my taxable income.
4. My wife and I have been thinking about opening a 403b for her, through her work. By doing so, we could reduce taxable income for 2008 – but NOT by as much as I thought. One of the selling points – mentioned several times by one particular financial salesman – has been the ‘fact’ that our taxes would be reduced ‘by 25%’. Clearly, that isn’t the absolute truth. Our taxes will be reduced, but the EFFECTIVE rate of reduction will be much less than 25%.
5. Our tax system is very, very, very difficult to understand. I would prefer a flat-tax or a national sales tax – if only for the sake of simplicity.