One of those things from high school…
…That I just don’t remember. Back then we reviewed the type of income tax system the United States follows and the different types out there. We also spent a wild amount of time on things like Calculus and Geometry, things that I definitely use every day as a sales professional trying to purchase a home in a rising rate economy.
Any way – let us have a refresher on the tax system in the United States and what it actually means for your income.
The United States uses more than one
Why use just one when you can make it complicated? Well it’s not just about making it complicated but instead what makes sense (in certain peoples opinions) for the goods or services. Before explaining where we stand in The United States let’s make sure we follow along with the people really in charge of the taxes – the IRS. Per the IRS…
1) Progressive Tax – A tax that takes a larger percentage of income from high-income groups than from low-income groups.
2) Proportional Tax – A tax that takes the same percentage of income from all income groups.
3) Regressive Tax – A tax that takes a larger percentage of income from low-income groups than from high-income groups.
In The United States, we experience an income tax that is progressive and regressive Social Security and property taxes. While they’re pretty easy to read into and do a bit more research on (If you really want to dive into the IRS supplied details here you go), the misconception (or complete ignorance in my case) is that progressive tax on our income means our whole paycheck. As in if you’re in the 24% tax bracket your entire paycheck is taxed at 24% – that’s just not the case.
Income Tax Example Most Americans Don’t Know!
For tax year 2024 (taxes due 2025), here are the 7 tax brackets. Although I took an accounting class and had to go through economics in high school, I still didn’t connect the dots that your entire income is not taxed at the highest bracket you’re in. I want to blame the fact that so many people will respond that “I’m in ‘X’ tax bracket” and then we’re over here assuming we pay the entire bill at that rate. Here’s the example…
Since I’m not married we’re going to make this easy and say the person is filing single making $120,000 with no other income. We’re also not going to play the game of retirement contributions, investments, or any other creative way to reduce your taxable income because I promised simple.
In my original understanding as I was just entering the workforce (along with 49% of Americans not knowing what bracket they’re in), I thought I’d be paying the 24% tax on all $120,000 which would equate to $28,800. How it actually works is that the percentage used is only applicable to that range! So anything over $100,525 would be taxed at 24%. Meaning the taxes for the $120,000 would be…
10% – $1,160 (tax on $11,600)
12% – $4,266 (tax on $35,550)
22% – $11,742.50 (tax on $53,375)
24% – $4,674 (tax on $19,475)
Total Tax Bill – $21,842.50. That’s $6,957.50 less than my wild math I’ve been doing.
Now for the fun part
For Well taxes really aren’t “fun.” What is fun is working with a CPA that can help you legally reduce your Gross Income (all sources of taxable income) to your Taxable Income (Income you’re actually taxed on based on allowable deductions). This is how the ultra risk like Elon Musk, pay such low tax rates. Other than the massive difference in wealth from the average American, the same allowable deductions are there for every single person it’s just have the access to someone who can help you get there and the know how.
