What am I saying, I’ve got a huge project due at work today. Well, I hope you are having a happy Monday.
Regardless, thanks for joining me. I don’t take a single reader or follower for granted.
Alright, let’s talk money myths. Last year, my cousin and I were talking about money while we were playing tennis. Naturally. My cousin is financially savvy, very in-the-know when it comes to money speak.
Taxes came up and she mentioned that she and her husband were trying to keep their income below a certain point to avoid the bump in overall taxes. She said they didn’t want to make less money just because they entered a higher tax bracket. I was confused because that’s not how tax brackets work.
This was a simple misunderstanding, certainly nothing against her. But if a financially savvy individual doesn’t understand how tax brackets work, how many other people is it incredibly confusing to?
Let’s break down tax brackets
Alright, let’s do this!
Tax brackets are broken down into levels of income and corresponding percentages paid in tax to the federal government. There are more categories than this but we’ll show the most common, single or married and filing jointly.
Single Filer Tax Bracket
Married Filing Jointly Tax Bracket
Here’s the myth
Now that you have the IRS tax brackets for 2020 in front of you, it’ll be easier to understand what I’m talking about. Here’s the myth that many people including my cousin believe.
Myth: If I’m married and filing jointly, we’ll be paying 22% in taxes instead of 12% if we make even $1 more than $80,250.
If this couple made $80,250, the myth would say that this couple would pay $9630 in taxes (12% of $80,250). This would leave them with $70,620. And if they made $80,500, they would pay $17,710 (22% of $80,500). This would leave them with $62,790.
If this were the case, you can understand why this couple would want to avoid the extra $250 of earning. It would save them $8080 in taxes and come home with more money, clearly worth losing the $250 of extra income!
Here’s the bust
Here’s how it actually works. Let’s take the same couple making $80,500.
First they would pay 10% of the first $19,750. That’s $1975.
Next they would pay 12% of the amount over $19,751 but under $80,250. That range is $60,499.
That means they would pay 12% of $60,499. That’s $7260.
Then they would pay 22% of anything over $80,251 but under $171,050. Since they make $80,500, we only care about the $249 over $80,251.
So they would pay 22% of $249. That’s $55.
Given their income, they fit into the 22% tax bracket but they don’t pay 22% on their full income.
To figure out their final tax bill, we take the $1975 from the 10% bracket, the $7260 from the 12% bracket, and the $55 from the 22% bracket and add them together.
They would owe the IRS $1975 + $7260 + $55 = $9290
I hope you now understand how relatively simple tax brackets really are! And I hope you won’t worry about making more money because you won’t lose more money in taxes than your increase in income.
In the case of our lovely couple, their last $249 was taxed at a higher rate of 22%, but they still came away with $194 more after tax than they would have if they didn’t make that extra money!
Long story short, if you get the opportunity to make more money, do it. You won’t come out financially any worse than if you didn’t.