Home / The Latest New In Home-Based Business / Income Tax Buckets Not Income Tax Brackets

Income Tax Buckets Not Income Tax Brackets

Picture of income tax bucketsAre you ever confused about how income tax brackets work? Lots of people are. And for those people, I have an idea. Don’t think about income tax brackets. Think about income tax buckets.

Thinking in terms of income tax buckets makes a lot more sense. And it gives you an easy handle on the math.

You can, in fact, use the concept of income tax buckets to think about standard and itemized deductions, personal exemptions, and then all of the tax rates. And even to see how some people pay zero income taxes. But I’m getting ahead of myself.

Income Tax Buckets for Deductions

Let me give you an example about how this works. You maybe know that you can put a standard deduction on your tax return that for 2016 equals $6,300 if you’re single, $9,300 if you’re filing as head of household, or $12,600 if you’re married?

What do these deductions mean? They’re income tax buckets. And whatever otherwise taxable income you “pour” into the bucket doesn’t get taxed.

For example, if you’re single, you can “pour” up to $6,300 of income into your standard deduction income tax bucket and escape from paying income taxes.

And if you happen to be married and file as a couple, you can pour up to $12,600 of income into your standard deduction income tax bucket.

A tangential aside: Most people don’t itemize their tax deductions, but you can total up the amounts you spend on things like mortgage interest, property taxes, state income taxes and charitable contributions and use this total in place of your standard deduction. This approach in effect gives you an itemized deductions income tax bucket.

Note: If your income rises to healthy six figure level, tax law either eliminates your opportunity to use an itemized deductions tax bucket (thereby forcing you to use a standard deduction income tax bucket) or tax law makes the itemized deductions income tax bucket way smaller…

Income Tax Buckets for Personal Exemptions

Here’s another example of how the income tax buckets concept helps. You get a $4,050 income tax bucket for every member of your family.

To keep the math easy, suppose you have a single person—you—in your family. In this case, you can pour $4,050 of otherwise taxable income into this income tax bucket and thereby escape tax.

Note: If your income rises healthy six figure level, tax law also takes away your personal exemption income tax buckets.

Tax Rate Income Buckets

When people use the phrase “tax bracket” they think about the percentage rates that get used to calculate income taxes. But really, you’ll find it easiest to think about these percentage rates as income tax buckets, too.

The first tax rate “bracket” says income is taxed either at 0% or 10% and applies for single people on up to $9,275 of income, for head of household filers on up to $13,250 of income and for married couples filing jointly on up to $18,550 of income.

So here’s the way to think about this income tax bracket as a bucket.

Let’s say that you have three jobs, no kids and file as a s single taxpayer. Further, to keep things really easy, say you have three W-2s: one for $6,300, one for $4.050 and one for $9,275.

In this case, you can “pour” the $6,300 chunk of income into your standard deduction income tax bucket and pay zero income taxes on that income. You can then “pour” the $4,050 chunk of income into your personal exemptions income tax bucket and pay zero income taxes on that income. Finally, you can “pour” the $9,275 chunk of income into the first “10%” income tax bracket and pay $927.50 of tax on that income.

And now a weird little anomaly: When you talk income tax rate brackets, long-term capital gains and qualified dividends gets taxed not at the normal income tax rate but at a discounted rate.

The first two income tax rate brackets tax almost all income at 10% and 15%, for example. But if you pour long-term capital gain or qualified dividends into either of these buckets, the rate equals 0%.

For example, let’s say you have two jobs—one where you earn $6,300 and one where you earn $4,050. Let’s also say that you receive $9,275 of dividends from a corporation that’s paid income taxes on its profits. (This is what creates a qualified dividend.)

In this case, you “pour” the first $6,300 W-2 into that standard deduction income tax bucket and pay zero income taxes on that income. You pour the second $4,050 W-2 into the personal exemption income tax bucket and pay zero income taxes on that income. And then you pour the $9,275 of qualified dividends into the “10% income tax rate bracket” bucket. But you pay the discounted 0% tax rate–which again means zero income taxes on that income.

Notice something subtle happening here: Tax accounting rules pour your income into your income tax buckets in a way that minimizes your taxes. For example, in the preceding paragraph, the W-2 chunks of income get poured into the buckets where that income is taxed zero.

Reviewing the Tax Rate Income Tax Bucket Sizes and Rates

The table below gives you the various income tax buckets for the married filing joint status and lets you see what happens when your income gets subjected to multiple tax rates.

Rate Discounted Rate Married Joint Bucket
10% 0% $18,550
15% 0% $56,750
25% 15% $76,600
28% 15% $79,550
33% 15% $181,900
35% 15% $53,600
39.6% 20% Everything that’s left

You don’t need to memorize the numbers. You just want to know this conceptual point: You fill up these income tax buckets one by one, starting with the lowest rate buckets.

Let’s say, for example, that you are married and that between you and your spouse, you have one $28,800 W-2 that you “pour” out into a $12,600 standard deduction bucket and then four $4,050 personal exemption buckets.

Let me do the math for you: $12,600 + $4050 + $4050 +$4050 +$4050 = $28,800.

That $28,800 W-2, as a result, escapes income tax.

Then suppose you have another W-2 that equals exactly $18,551. So you would pour the first $18,550 of that second W-2 into the 10%0% tax rate bracket… and then only $1 into the 15% income tax bucket.

You see what happens, right? Only a few “drops” of income get subjected to the higher percentage rate.

People sometimes worry about tripping over into a higher tax rate percentage. The fear, I think, is that you somehow “lose” the opportunity to “pour” income into a low bracket bucket. But that doesn’t happen. And, in fact, you typically feel little effect from tripping over into another higher tax bracket.

Paying Zero Income Tax with a $100,000 Income

Can a make a brief digression? When you use the income tax buckets concept, you see clearly how some people avoid paying income taxes in retirement.

Suppose a married couple receives $20,700 in taxable pension benefits. Maybe this is their taxable Social Security. That $20,700 might get poured into the $12,600 standard deduction bucket and then a couple of $4,050 personal exemption buckets. As result, no income tax gets paid on that income.

Further suppose that the couple receives $18,550 of qualified dividends from one mutual fund it owns. That income gets poured into the 10% income tax bucket, but because the income represents qualified dividends, the income gets taxed at 0%.

Finally suppose that the couple also receives $56,750 in qualified dividends and long-term capital gains from another mutual fund it owns. That income would be poured into the 15% income tax bucket, but oddly it also gets taxed at 0%.

This married couple, in short, earns nearly $100,000 in annual income. The dividends and capital gains they enjoy probably reflect millionaire status. But they pay zero income taxes.

Closing Caveats

Hopefully, you can use the concept of income tax buckets to better understand how your taxes get calculated. But you want to be alert to a handful of additional complexities.

First, tax law does give some tax payers special additional income tax buckets. If you work overseas, for example, you can get a special income tax bucket, called the foreign earned income exclusion bucket, that lets you avoid paying US income taxes on income you earn outside the country.

Second, this little blog post doesn’t talk about income tax credits. But income tax credits erase some or all of the tax owed by many taxpayers. Low and even median income taxpayers, for example, commonly have their income tax bill zeroed out completely because of these credits.

Third, and finally, the net investment income tax (also known as the Obamacare tax) and then the alternative minimum tax (also known by the acronym AMT) use their own separate “income tax bucket” systems. Fortunately, most income taxpayers don’t have to worry about these other taxes.

Other Related Blog Posts You May Enjoy

Real Estate versus IRA and 401(k) Accounts, Part I

Why You Don’t Need to Worry about Taxes in Retirement

Your CPA versus TurboTax



The post Income Tax Buckets Not Income Tax Brackets appeared first on Evergreen Small Business.

Click Here For Original Source Of The Article

Ads by WOW TRK

Check Also

Bohemian Revolution Beverage Co. Founder Brandon Johnson Shares His Business Journey

Bohemian Revolution Beverage Co. founder Brandon Johnson shares the business journey he took in launching his successful line of supplement powders.

The post Bohemian Revolution Beverage Co. Founder Brandon Johnson Shares His Business Journey appeared first on Home Business Magazine.