Friday, July 5, 2013

Tax Series #4: What's the deal with tax brackets?

Okay, it's time to clear up a myth about tax brackets.

Say you're at a cocktail party and your friend, Judy, starts complaining about how her bonus is going to push her into a higher tax bracket this year (life's rough). 

Judy: "Because I do such an amazing job at work my boss wants to give me a bonus. He really wants to keep me, I guess. I make $77,851 right now, and he's giving me a $10,000 just as a way of saying, 'Judy, you're awesome!' Getting the extra money is nice, but because the 25-percent tax bracket ends at $87,850 and now I'm making $87,851, all of my money is going to be taxed at 28 percent instead."

You: "Ummm.... That's not really how tax brackets work." *Proceed to amaze everyone present with your knowledge of tax brackets and money-hip-mama-ness.

So what is the truth about tax brackets?


First, let's show what the tax brackets are for 2013. (Click here for more detailed brackets from bankrate.com.)


 So, Judy was right that the 25-percent bracket ends at $87,850 for single taxpayers. BUT, only the amount of money in the new 28-percent bracket (i.e., that one additional dollar that puts her at $87,851) will be taxed at 28-percent. Think of your income as a cake. (By the way, Lisa and I like decorating cakes-- we are not good at it though, remember, we're accountants.) All the money you make represents the whole cake. We divide it into slices (each slice representing a different tax bracket). Only the money within that slice is taxed at the rate for that bracket.

Take our friend, Valerie, for example. (She went to school with us, and we're trying to coerce her into writing a few guest posts for us.) Let's say she makes $87,851 just like our friend Judy (we, of course, are making up amounts). Then she'll have a slice of that taxed at 10%, a slice taxed at 15%, a slice taxed at 25%, and the teeniest little sliver of a slice taxed at 28% (as pictured below next to the birthday cake I made her in college).

That means her total tax is $17,892 ($893 on the 10-percent slice, $4,099 on the 15-percent slice, $12,900 on the 25-percent slice, and a whole $0.28 on the 28-percent slice).

I made this cake for Valerie in college when we were roommates. Our apartment had a Wii, so I tried to put her  "Wii Mii" on the cake. 

FYI, Lisa and I did graduate from Wilton Course 1.

And here the arrow is pointing to where I stuck my finger in my cake when Lisa told a hilarious story about a kidney stone-- which I have come to understand is no laughing matter.
Ask Away - What are some tax/money myths you want to clear up?


Speak Up - What are some popular misconceptions that drive you nuts?


For Fun - Did anyone else take the Wilton class?

4 comments:

  1. I'm honored to be part of this blog already. I love everything you've posted so far! So helpful! I'll have to do some brainstorming for some future guest posts...

    ReplyDelete
    Replies
    1. You better believe we will be hitting you up for some guest posts... :)

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  2. I love this post! I have definitely had this conversation with "Judy", but I didn't understand like I do now. There is so much misinformation out there. Thanks for clearing some of it up.

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