This is how the income tax actually works

Since tomorrow is the income tax deadline and a lot of people plan on protesting taxes on the basis that they hate paying money, I thought I would finally do a little write-up on how to actually determine how much you owe in taxes.  Basically all you need to know is that anyone that tries to tell you that it is possible to make less money by earning more is wrong.

First off, here are the current tax brackets:


Tax BracketSingleMarried Filing Jointly
10% Bracket$0 – $8,375$0 – $16,750
15% Bracket$8,375 – $34,000$16,750 – $68,000
25% Bracket$34,000 – $82,400$68,000 – $137,300
28% Bracket$82,400 – $171,850$137,300 – $209,250
33% Bracket$171,850 – $373,650$209,250 – $373,650
35% Bracket$373,650+$373,650+


Before I explain the common misconception about these tables, first I'll explain deductions.  Everyone receives a standard deduction of $5700 (or $11400 for couples).  If you choose to itemize deductions (medical expenses, work expenses, etc.) then you waive this standard deduction.  The tax form is designed to calculate which of the two would grant you the bigger deduction.  Where-as credits are a direct lowering of taxes due, deductions lower your taxable income, so if you make $40,000 in a year and have no itemized deductions, your income for the purpose of taxation is $34,300 (40,000 - 5700).  Tax-free contributions such as 401k are taken out prior to tax calculations, so you don't have to worry about those as actual deductions.

Now, here is where the common misconception regarding taxes lies:  we have a PROGRESSIVE tax.  What this means is that you are taxed on the next dollar earned, not the total income.  Here's a demonstration:

Most people that don't understand taxes believe that someone making $40,000 would owe $10,000 in taxes (40,000 * .25)

In reality, someone making $40,000 would only be taxed on $34,300, as demonstrated above.  Additionally, their tax breakdown would be as follows
$8375 * .1 = $837.5
25625 (34000 - 8375) * .15 = $3843.75
300 (34300 - 3400) * .25 = $75

837.5 + 3843.75 + 75 = $4756.75

Notice how the income earned within the first tax bracket is taxed within the first tax bracket?  This is what makes it mathematically impossible to actually lose money by increasing your income.  Also notice that the total amount in taxes is LESS THAN HALF what the incorrect method stated?

This amount would be deducted from the paycheck over the course of a year, hopefully somewhere around $91.50.  Depending on the withholdings set on the W-4, it will probably be a little more or less than that, which determines whether you receive a refund or owe money.  Refunds don't mean you didn't make enough money, they mean that you paid too much and gave Uncle Sam an interest-free for the year.

Remember all this the next time someone complains to you about making too much money!