Last year I tried to understand how all of this tax stuff worked, and I couldn’t determine why I couldn’t get the same number as my accountant when I calculated my tax liability. In this post, I will discuss how to calculate the taxes you owe, which is based on how you file and the amount of money that you make.
Below are figures for each type of filing: single, married filing jointly, married filing separately, and head of housed. I will use an example to depict how the calculation works – it is actually very simple.
Let’s take a look at a single woman, Jess, that makes $95k per year. Her tax liability is not $26,600, which is 28% of $95k. Here is how you calculate her tax liability using the projected tax brackets for 2016.
The first $9,275 of the $95k that she makes will be taxed at 10%, which is $927.50. Next, she would need to calculate the amount of tax she owes for the next tax bracket, which is 15% of $28,374 ($37,650 – $9,276). This equals $4,256.10. So we know that if a person makes $37,650, their tax liability is $4,256.10 + $927.50 = $5,183. We do the same calculation for the next tax bracket: 25% of $53,499 is $13,374.75 ($91,150 – $37,651). Remember, you need to add in all previous tax brackets for a total of $18,559. Finally, for the last calculation you take $95,000 – $91,151 = $3,849. 28% of $3,849 is $1,077. Therefore, Jess’s total tax liability for the year would equal $19,637. This is significantly different compared to the $26,600 I originally calculated.
Common Myth on Tax Brackets:
As I pointed out in my example, taxes are calculated on a tiered or marginal tax rate and NOT a flat tax rate. This is important to note because I hear many people talk about trying to reduce their taxable income to get into a lower tax bracket, or people become concerned when they get a raise because they think their tax bill will go up (which it will, but not in the sense that most people think). Because of this marginal tax rate, it doesn’t matter! If a person goes from making $37k to $40k, the only difference is the extra $2,350 ($40,000 – $37,650) that the person makes, which will be taxed at 25%. Therefore, their tax bill will be $5,770 and not $10,000 ($40,000 X 25%) for jumping into the 25% tax bracket.