What is this?  He’s gonna talk about taxes?

Well, yes – but let me explain.

While I hate tax season just as much as the next person, I understand that they are a “necessary evil”.  Taxes pay for lots of services and infrastructure that we take for granted on a day-to-day basis, such as fire and police protection, roads, and education (to name just a few).

Now, I’m not going to sit here and debate about what is “good” or “fair” tax policy, but what really grinds my gears is when people talk about their taxes without a clear understanding of how they work.  There are a lot of myths and misinformation out there, and I want to focus on the biggest falsehood I hear all of the time – “ohh, that raise at work put me in a higher tax bracket – I’m gonna get killed by Uncle Sam, it just wasn’t worth it”.  Now granted, there may be a few cases where a person’s taxes go up significantly (due to a lot of extenuating factors other than that recent pay raise), but let’s break down how the tax brackets themselves ACTUALLY work.

First off, let’s look at the current tax brackets for 2020:

Rate	For Single Individuals	For Married Individuals Filing Joint Returns	For Heads of Households
2020 Federal Income Tax Brackets and Rates for Single Filers, Married Couples Filing Jointly, and Heads of Households
10%	Up to $9,875	Up to $19,750	Up to $14,100
12%	$9,876 to $40,125	$19,751 to $80,250	$14,101 to $53,700
22%	$40,126 to $85,525	$80,251 to $171,050	$53,701 to $85,500
24%	$85,526 to $163,300	$171,051 to $326,600	$85,501 to $163,300
32%	$163,301 to $207,350	$326,601 to $414,700	$163,301 to $207,350
35%	$207,351 to $518,400	$414,701 to $622,050	$207,351 to $518,400
37%	$518,401 or more	$622,051 or more	$518,401 or more
Source: Internal Revenue Service

The most common misconception is that a higher rate applies to ALL of one’s earned income, but that’s simply not true.  The U.S. works on what’s called a “marginal” tax rate system, which means that citizens are taxed according to what part of their income falls between the established parameters set by the Federal government.  This is clearly illustrated in the chart above.

Let’s say – for example, that you’re a single guy and make $40,000 a year at your job.  You look at the chart and say to yourself – “OK, that puts me in the 12% tax bracket.”

And you’ve made your first mistake.

From the chart, you’ll see that any income up to $9,875 is charged at the 10% tax rate.  Any income from $9,876 up to $40,125 is charged at the 12% rate, so in this example, our single guy is actually paying TWO rates.  One for his earnings up to $9,876 (10%, so $987.60) and one for his earnings from $9,876 up to $40,000, which is $30,124 (and would be charged the 12% rate, or $3,614.88).  So in this example, our working man would owe $4602.48 in taxes ($987.60 at 10% plus $3,614.88 at 12%). 

A “straight” tax rate (where everything was charged at the 12% rate) would be $4,800 (a $197.52 increase over the marginal rate).

Now, let’s say that our hard working gent got a raise and now makes $43,000 a year.  Does his total tax rate jump from 12% to 22%? 

Not even close.

Based upon the chart, only the portion of income over $40,125 will be charged at the 22% rate, so in our example, $2,875 will be charged the 22% tax rate ($43,000-$40,125 = $2,875).  The rest will be assessed and charged at the same rates as our previous calculations.  Granted, 22% is higher than 12%, but that higher rate is only applied to the established rate tier ($40,126 – $85,525), not a person’s total income.

The myth (and propagated falsehood) here is that our man’s taxes have jumped from 12% to 22% (on his total income), which is absolutely not the case.

You’ll hear politicians play up this lie all the time.  They also play on people’s fears when any attempt is made to tax “wealthier” Americans at a higher rate (or create higher, more “expensive” tiers).  Look again at the chart.  Unless you make over $518,401 per year, you’ll never have to worry about a 37% tax rate (plus with all of the loopholes and deductions, I seriously doubt that anyone pays that high of a rate overall).  So, when there is talk about “raising” taxes on the wealthy – don’t worry – odds are, they aren’t talking about you (unless you are reading this from behind the walls of some exclusive, gated community).

In actuality, tax rates have significantly decreased over the past 40 years.  If we used the same example above, but applied the tax rates from 1980, you’d have experienced quite a different story.  In 1980 – on income from $31.4K – $41.5K – the tax rate was a staggering 49%.  Yeah, you read that right – almost half of the income made in that specific range would have been taxed at almost 50%.  Think that’s high?  Guess what the top rate was in 1980?  70% (for any income over $108K).  Ouch.

So, the next time someone starts complaining about their taxes, you now have a little better understanding of how they function (and will know who is feeding you a bunch of garbage).

You’re welcome.