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How do tax brackets really work?

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Clients often tell me that they don’t want to make more money because they don’t want to go into the next tax bracket.  They are often surprised when I tell them not to worry about that and make as much money as they want!

The easiest way to explain our tax bracket system is with an example:

Sam is single and has taxable income of $82,501.  Sam’s taxes are calculated as follows:

Bracket 1: The first $9525 of income is taxed at 10%

Bracket 2: His income between $9526 and $38700 is taxed at 12%.

Bracket 3: His income between $38701 and $82500 is taxed at 22%

Bracket 4: His income above $82501 is taxed at 24%

So, Sam’s tax due is $14,096 for the year.

Notice that even though Sam has income in the 4th bracket, it does not mean that all his income is now taxed at 24%. (If that was true, he would have owed $19800 in tax.) Only the $1 that sneaks into that bracket is taxed at 24%.  All his other income is taxed at lower rates.

Now, that being said, there are a few cliffs in our tax law where making another dollar could make a material difference on your taxes (e.g. the CA LLC gross receipts fee and the mental health tax) so please be sure to keep your Enrolled Agent informed of all material changes to your tax situation.

 

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