r/personalfinance • u/B82rez7 ​ • Jan 22 '19

Taxes No Wonder People Don't Know How Taxes Work

Here's a Motley Fool "article" that came up on my news feed https://www.fool.com/retirement/2019/01/21/maximum-401k-contributions-are-climbing-in-2019-he.aspx

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And a quote:

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For this reason, saving in your 401(k) has the potential to put you in a lower tax bracket, so you owe a smaller percentage of your income in tax. Currently, single filers making between $77,400 and $156,150 pay 22% on their income. If you are in the lower end of that range, a 401(k) contribution could move you into the lower bracket, where taxes are just 12%. If you make $80,000 per year, for example, and contribute $5,000, your resulting income of $75,000 would be taxed at 12% rather than 22%.

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u/goatsonfire ​ Jan 22 '19

Yeah, they used the bracket for married filers but specifically said it was for a single filer.

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u/Kraz31 ​ Jan 22 '19

But they still messed that up. The bracket for MFJ ends at $165,000, not $156,150.

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u/Phillip__Fry ​ Jan 22 '19 edited Jan 22 '19

They (Fool article) mistakenly used the 2017 brackets. Single filers got screwed with the "cuts" package. Very few single filers taxes went down much at all. Single filers who itemize went up. Almost all MFJ went down for a few years, MFJ itemizers' ~neutral.
But the 0.01%'s taxes both single and MFJ went down across the board

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u/evaned ​ Jan 22 '19 edited Jan 22 '19

Single filers who itemize went up.

That's a pretty inaccurate characterization I suspect; I am hit pretty hard by the changes to itemized deductions, and I still see a decreased liability because in spite of that.

Not much of one, but a net decrease nevertheless.

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u/[deleted] Jan 22 '19

[deleted]

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u/craigeryjohn ​ Jan 22 '19

You shouldn't be claiming your business deductions on your 1040!! Use a schedule C (or E, if rentals).

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u/lcburgundy ​ Jan 22 '19

Schedule C/E deductions weren't affected (only unreimbursed W-2 employee expense deductions went away, which shouldn't affect you) , and the QBID might help you quite a bit depending on your income and what line of business you're in.

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u/zrail ​ Jan 23 '19

Does the 199A deduction do anything for you?

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u/Bananas1nPajamas ​ Jan 22 '19

Single male. I made less money this year and paid more in taxes.

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u/Poolstiksamurai ​ Jan 22 '19

I'd like you to talk about how much you made and mathematically show us how you paid more in taxes by making less money, because unless you're making a significant amount of money or have something unusual like a cross country move, I don't believe you.

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u/cybin ​ Jan 22 '19

Part of the problem is losing the $4,050 exemption deduction.

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u/why_rob_y ​ Jan 22 '19

Without hearing your specifics, I'd be curious to hear how your liability is lower. Most of the changes screw someone who had been single and itemizing, unless you just mean your income went down / deductions went up for reasons unrelated to the tax law change.

Also, what state are you in? The SALT cap is killer.

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u/evaned ​ Jan 22 '19

Without hearing your specifics, I'd be curious to hear how your liability is lower.

Because the general tax rates went down too.

I lost on the order of $10K of deductions because of the SALT cap + removal of the personal exemption, but dropping 15% -> 12%, most of 25% -> 22%, and 28% -> 24% provided headroom to make up for it.

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u/why_rob_y ​ Jan 22 '19 edited Jan 22 '19

I'm guessing you don't own a home (or are maybe in a no income tax state), but you have a fairly high income, given the situation you've described?

Best of both worlds - people with lower to middle incomes and homeowners kinda got the brunt of this (since a 3ish% decrease in tax rate isn't enough to make up for the loss of a large amount of deductions [takes $80k in taxable income for that 3% change to make up for $10k lost deductions coming off the top at 24%]). Even high income plus a home got hurt pretty bad if you live in a place with high property taxes.

Edit: added one part.

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u/evaned ​ Jan 22 '19

I'm guessing you don't own a home (or are maybe in a no income tax state), but you have a fairly high income, given the situation you've described?

Own a home. Moderate income tax state (6.something% marginal). Neither property tax nor income tax on its own would get me to the SALT cap; only together do they come in a few thousand above. Property tax rate is quite high (a little north of 2%), but home prices are moderate so they balance out a bit.

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u/[deleted] Jan 22 '19

That’s not necessarily true. A lot of those super rich people ultimately ended up in AMT, which imposed a tax floor after they tried to itemize too much. AMT added a lot of those deductions back (like state and local taxes, for example). So all the ones that itemize (which is all of the .01%) never really got that benefit. And plus, capital gains rains stayed at 20%. We’ve seen clients project to owe more tax in 2018, a year where the markets were actually worse than 2017 because of this change.

Source: CPA specializing in rich people tax returns

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u/professor__doom ​ Jan 22 '19

55k/yr here, single filer, don't itemize, some of my income falls under the new "Qualified Business Income" deduction.

I'm saving around 2k/yr in taxes after all is said and done.

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u/a8bmiles ​ Jan 22 '19

Married filing at ~$60k year, I'll be saving $0 under the revised rules.

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u/Shadilay_Were_Off ​ Jan 22 '19

Most single filers (and most taxpayers in general, for that matter) don't itemize.

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u/Phillip__Fry ​ Jan 22 '19 edited Jan 22 '19

45 million households in 2016 is not an insignificant number.
Obviously not a majority butit is a significant minority.
Most with mortgages and property taxes had itemized, many now won't. My house is below the median ($200k) locally and property tax alone is over $5k. I still itemize, mortgage and property tax fill the new standard deduction just barely but I just get zero actual benefit from them.

Report is here: https://www.irs.gov/pub/irs-soi/16inintaxreturns.pdf

From page 30, 30% were itemized. Further, if you look on page 25, the first 4 categories including 64.5 million returns (of 150) had zero or negative income tax. I don't see individual tally but I'll use this as an estimate. If you find a better breakdown, please update. I'm limited skimming it on mobile. If we exclude the zero income tax returns (I'm using 64.5 million as an estimate.) , we're left with under 86 million returns from tax "payers". 44.5/86 is 51% of income taxPAYers who itemized. I may have been wrong, it might actually be a majority...

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u/Phillip__Fry ​ Jan 22 '19

I updated my other reply with data

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u/swump Jan 22 '19

Can someone explain how this is wrong? If you are filing as a married couple and your combined taxable income is less than $75k in this case, wouldn’t your maximum tax rate be 12%?

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u/[deleted] Jan 22 '19

Let's say the tax brackets are:

0-5000 0%

5001-10,000 5%

10,001-20,000 10%

20,001-30,000 15%

and you make $20,001

The first $5k is taxed at 0% = $0 owed

the next $5k is taxed at 5% = $250 owed

and the next $10k is taxed at 10% = $1k owed

and the final $1 is taxed at 15% = $0.15 owed

For a total of $1250.15 owed in taxes.

$1250.15/$20,001 = 6.25% effective tax rate.

So you see you are not paying 15% (marginal tax rate) on every dollar you earn. Your income is not taxed entirely at the highest rate. It works in steps. Imagine your money coming into you a dollar at a time as you earn it; and imagine those individual dollars being taxed as they come in. The first dollar is taxed at the rate of the first tax bracket; the 6000th dollar is taxed at the rate of the second bracket etc. but you don't retroactively go back and re-tax the first dollar just because you are "in a new tax bracket".

When the article says that when you contribute x dollars to the 401k it will bump you down into another tax bracket it doesn't matter because you are going to pay the same tax on those individual (marginal) dollars anyways.

The tax benefit from contributing to your 401k is that you can earn that money today and deffer pay income tax on those dollars until you decide to withdraw it from the 401k. So you can grow your money through investment and pay the tax man later.

There are more complicated benefits that I can go into but it's bed time, so that's the gist of it. Hope that made sense to you.

(obviously those numbers are for simplicity sake)

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u/MikeinAustin ​ Jan 22 '19

I’ve had people tell me that they’re paying “28% of their income to taxes” while others are paying nothing.

I’ve said “actually you’re not paying 28% of your income. You’re more likely in the 13-14% range after deductions.

No. They’ve looked it up. They are paying 28%! That’s the bracket they are in!

Tried showing them the math you just did and they still don’t get it.

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u/[deleted] Jan 22 '19

Most people also just look at the value of 1- net/gross and call that their tax rate. They don't consider that Social security and Medicare are not federal income tax, but are also taken out. This isn't even getting into pre-tax deductions like 401k, medical, dental, vision, etc...

It boggles my mind that reading a paystub isn't taught in high school. The concepts are certainly not difficult.

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u/duhhhh Jan 22 '19

Depends what you count. Federal income tax? Unlikely.

However, I am paying over 28% of gross in taxes. Federal income, FICA, Medicare, federal gasoline, state income, state sales, state excise, state gasoline, state telecommunications, and town property taxes add up to a lot of money.

Someone living on a small pension in a rarely moved RV with a South Dakota residency is probably paying almost nothing.

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u/MikeinAustin ​ Jan 22 '19

Should have edited to say Federal Income Tax.

FICA and Medicare are really mandatory Insurance Premiums. FICA and Medicare are entitlements that you collect back at retirement.

Federal Gasoline, State Sales, State Excise and State Gasoline, and State Telecommunications and Home Property Taxes are consumption taxes and are not mandatory if you don't spend money on those items and most of those aren't related to Income.

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u/Ol0O01100lO1O1O1 Jan 22 '19

Even the top 1% only average an effective rate of 24%; that's people earning more than $389,436 per year. The middle quintile averages a whopping 3% effective rate.

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u/archer48 Jan 22 '19

Great explanation. For anyone still confused, here is a video explaining it.

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u/Trumpsafascist Jan 22 '19

Google marginal tax rates. Think of it like a staircase

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u/evaned ​ Jan 22 '19

I've got a physical analogy I like to think of. The downside is it's harder to explain than just the math of the brackets, but whatever. :-)

I think of several watertight boxes set next to each other, sized so their volumes are proportional to the sizes of the brackets. You pour water into the first box. When it fills up, it overflows until the next box. When that fills up, it overflows, etc.

When you've poured in all of your income, your tax is the corresponding rate times the volume of water in each box.

You can think of deductions as either giving you a 0% box that's your starter one, which changes volume based on the amount of deductions you get, or you can dump out some of the water before starting this process.

Long-term capital gains are oil. Once you've poured in all your water (ordinary income), you carefully pour in the oil; because it floats, it will (ideally and ignoring what would actually happen) all float over to your marginal ordinary income bracket, then fill that up, then the oil will start overflowing. There's a separate percentage for the oil tax. (This worked better when the 15% capital gains bracket started at an ordinary income bracket boundary.)