eli5 tax brackets

590 views
0

I know that the more money you make the higher the percentage, but is that all there is to it? How do the rich manage to not pay as much? Or do they pay as much?

In: Economics

The top 10% of wage earners in the US pay 90% of the federal income taxes that are collected in the US. The rich pay the highest tax rate, even though popular social media and news outlets like to portrait that they don’t. The fact is, they do, period.

Essentially the US works on a system where the more you make, the more you pay in taxes, and they do this in brackets.

There are seven federal tax brackets for the 2020 tax year: 10%, 12%, 22%, 24%, 32%, 35% and 37%. Your bracket depends on your taxable income and filing status.

https://www.nerdwallet.com/article/taxes/federal-income-tax-brackets

In a perfect system, the more you earn, the more tax you pay,

The issue with the system, is there are loopholes that you can “abuse” when you have enough money to pay an accountant full time to manage your asset’s. They do things like move it offshore, buy and sell houses, buy/sell expensive artwork, etc etc, that way your value in the eye of the government isn’t that much.

When people say “tax the rich” they usually don’t mean Bob and Jill who bring home 2-10 mill a year. Those people are still relatively poor, compared to the people who earn 100+ mill a year

First off, they’re marginal brackets, meaning you only pay the higher rate for dollars earned over that threshold, not your entire income. Everybody pays the same tax rate on the same dollar earned, you just pay more on the subsequent dollars earned, so whether you earned $50k or $500k, you still pay the same on that first $50k of income.

Some rich pay a lower percentage because they have businesses and can write off some expenses, like a car lease. Others make most of their money from capital gains, which are taxed lower than most income. And other see wealth grow on shares owned but don’t owe taxes until they sell, and can even borrow against shares to fund living expenses at a small interest rate while watching shares continue to appreciate in value.

Let’s dumb down the numbers.

Let’s say you make $100,000 a year.

Let’s say for every $10,000 you make you are taxes 10%

A lot people in that situation would wrongly think “oh no I made 100,000 so all my money is taxed 100%

But that isn’t how tax brackets work

What actually happens is you are taxed according to the income as you earn jt

So you pay $1,000 of the first $10,000. Because 10% of $10,000 is $1,000.

Then you pay $2,000 of the next 10,000 because your next $10,000 is a higher bracket.

This goes until you reach your highest bracket.

Using my example the total amount taxed is $55,000.

If you go by what people usually assume taxes are, all $100,000 is taxed

Think of tax brackets as envelopes you put your money into.

If the tax brackets are the following

$0-30,000 10%

$30,000-70,000 20%

70,000 – 150,000 30%

And you earn $100,000 you would put the first $30,000 you make in the 10% envelope, the next $40,000 you make (70,000-30,000) in the 20% envelope and the remaining $30,000 (100,000-70,000) in the 30% envelope.

Now the government is going to come and take 10% of the money the first envelope (30,000 * 0.1 = 3,000) 20% of the money in the second envelope (40,000 * 0.2 = 8,000) and 30% of the money in the third envelope (30,000 * 0.3 = 9,000) bringing your total tax bill to 3,000 + 8,000 + 9,000 = 20,000

So you’ll end up paying 20,000 or 20% of your 100,000 income in income tax even though you are in the 30% bracket. The bracket you are in is just the rate you pay on the top margin of your income, not your entire income. Your income is broken into pieces and each piece is taxed at a different rate.