Taxes are on my mind this month as tax season is in full swing.
Also you may have heard there is a Presidential election later this year. I probably
follow tax policy discussions more closely than the average bear, but I suspect
everyone will be hearing a lot about who does or does not pay their fair share of taxes
during the campaign.
What’s more, several provisions of the 2017 Tax Cut and Jobs Act, including lowered
individual tax rates are set to expire on December 31st, 2025. We will also be hearing a lot about whether these cuts should be extended.
Which bring me to the topic of today’s newsletter. How much Federal income tax do
you *actually* pay?
I believe every American should know the answer to this question.
In my experience, many people don’t have much of an idea what they pay. People who work for someone else typically pay most of their taxes via paycheck withholding.
Retired people often pay their taxes via IRA/pension distribution and/or Social Security
withholding.
The group most likely to know how much federal income tax they pay are self-employed taxpayers. They typically pay their taxes by writing quarterly estimate checks. (Or paying them online).
If you don’t know how much Federal income tax you actually pay, there is an easy way
to find out. When you get your 2023 tax return, take a look at your Form 1040 (or your
Form 1040-SR if you are over 65).
This is the main form and is usually toward the top of the stack.
Look on Page 2, Line 24:
This imaginary couple owes $28,521 of Federal Tax.**
If they had more than that withheld through the year they will get a refund. If they had less withheld, they will pay in.
How much did this couple make?
Look at Form 1040 on Page 1, Line 9: (on the 1040-SR Line 9 is on Page 2)
This couple made $200,000 and they owe $28,521 of Federal Income tax.
Their effective tax rate = 14.3% ($28,521/$200,000).
This couple’s $200,000 of income was wages earned working for someone else.
It’s possible they at Line 9 and say “Wait, I thought our salaries were more than $200,000 a year?”
Correct, not all wage income is taxable. Pre-tax contributions to a 401k/403b plan are not taxable. Contributions to a Health Savings Account are not taxable. Contributions to a Medical Flexible Spending account are not taxable. Employee health/dental/vision insurance contributions are not taxable.
More fun with tax software. Let’s look at a second imaginary couple. This time they each make $500,000 for a total of $1,000,000.
How much tax do they pay?
Note this couple makes 5x as much as the first couple, but they pay more than 10x as much tax.
Couple #2’s effective tax rate is 29.6%. ($296,415/$1,000,000)
I encourage you to look at your non-imaginary tax return when it’s complete to learn how much Federal income tax you *actually* pay!
**Notes:
If you are self-employed, Line 24 includes self-employment tax.
These two couples have no children (imaginary or otherwise), are under age 65, and took the standard deduction.
