Robin D : Hello and thank you for using Just Answer,
Robin D : Would you like to post your query?
Robin D : What area of the income tax did you want to ask a question about?
Customer: I want to clarify my current understanding of how tax brackets work for a US employee. I work for a large company, and my colleagues and I are often exchanging ideas about our taxes and especially in April. In my opinion, there are many fallacies among the public about how taxes work. So I want to clarify some of these facts.
Robin D : It may help if you ask a specific question.
Customer: of course. My general idea is...an employee earns a gross pay throughout the year (shown on W2), then applies whatever deductions are allowed, which reduces the gross to what will eventually be the taxable income. That taxable income falls into a bracket (perhaps 28% or 33%) and you will owe the IRS that percent. That amount is compared to what was deducted from your paycheck throughout the course of the year, and you will either owe the difference or be refunded the difference.
Customer: a common thing my colleagues often say when discussing what we earn is...
Robin D : Basically on point
Customer: do not earn too much, because you will lose it all to taxes!!! In fact, there is a common thought that there is a magical "amount" that you should stive to earn that will keep you "in a certain bracket, without going over".
Customer: But I think that is incorrect. Because I think...
Robin D : You will not lose it all to taxes. The thought to stay withon a certain amount may be due more to refundable credits afforded to lower income eraners
Customer: that even if you earn a whole bunch of gross pay over the 83,000 bracket, you are only taxed at a slightly higher percentage, and only for the portion of earnings over the 83,000 threshhold.
Robin D : An individual should always look to their W4 for the correct amount on withholding. The allowances are there to help in calculating the amount of tax that will be due at the return filing.
Robin D : The thought to limit one's self to a lower income would have to be taken into the fact that at higher levels the individual can purchase a home, invest, and save for higher education
Robin D : All of which would afford deductions in the tax that the lower earner would not be afforded
Customer: I worked a whole bunch of overtime last year, and the first thing colleagues would say to me were, "didn't you pay so much taxes on that income that it wasn't even worth it? ($135,000) And I felt like saying "NO".
Robin D : It was not for nothing.
Robin D : Here is a very good site that explains it easier than I could repeat
Robin D : http://www.obliviousinvestor.com/income-tax-101-tax-brackets-and-withholding/
Customer: "first of all, my dedcutions brought my taxable income down to about 100,000, and so I was taxed at 28% up to 83,000, and then 33% for the 17,000 above that. So for me to try to limit my income to 83,000 to avoid more taxation makes no sense".
Robin D : You are correct
Robin D : As I said there are many other things to consider in the mix
Customer: Now, my own tax preparer once said..."if you earn a large check in one particular month, the IRS will withhold a larger percentage than normal for that paycheck. They will withhold as though you would earn that for the entire year." But even if that happens, and they withhold great amounts, I still can get that back in a
Customer: April if I am able to deduct a lot.
Robin D : Yes, this happens with bonuses too
Robin D : The totals are used for the tax filing so if the extra on that one payment were higher then a refund would be in order
Customer: As I see it, the goal is to earn as MUCH as humanly possible, then deduct according to IRS codes as MUCH as humanly possible, and then pay the tax that you owe.
Robin D : Yes, although one is allowed to change their W4 and include the allowances so no more withholding is made than realistically required.
Robin D : After all a refund is just one's own money returned (without interest)
Customer: I do not see how there is any financial benefit, for someone who has the capacity to earn between 80,000 and say...140,000, to "limit" their earnings.
Robin D : Me neither
Customer: but there are tons of employees who believe that.
Robin D : Except under those refundable credits
Robin D : There are certain credits that are refundable
Robin D : meaning you get something for nothing (no additional withholding)
Customer: right, but thats for poor people.
Robin D : Poor is a relative term
Robin D : directly related to the amount in one's wallet
Robin D : my mother used to say :)
Customer: I juggled my W4 over the years because I was getting such large refunds.
Customer: I now claim a high W4 and still get money back. (i have rental properties)
Robin D : You have items that allow you to reduce your income which is good
Customer: can you reiterate again, about the refundable credits?
Robin D : The credits taht are refundable allow someone to get back additional money not just reduce their liabiltiy
Robin D : But
Robin D : they all have a dollar limit
Robin D : So there are those that believe getting back $5000 in a refund is better than making an extra $10,000 by working
Robin D : These are the income limits for EIC
Customer: I understand what you are saying. But the part I'm not clear on is, who is elgible for these types of credits?
Robin D : $45,060 ($50,270 married filing jointly) with three or more qualifying children$41,952 ($47,162 married filing jointly) with two qualifying children$36,920 ($42,130 married filing jointly) with one qualifying child$13,980 ($19,190 married filing jointly) with no qualifying children
Customer: I'm single with no children
Customer: children seems to be the magic pill.
Robin D : $13980 would be the most you could make
Robin D : and then you would have only gotten $475 at the highest level of refund
Robin D : So you can see how someone would be tempted to think that limiting their income would be a benefit
Customer: Well, anyone earning 13,980 probably deserves a refund.
Customer: I understand.
Robin D : In 2012 $5,891 with three or more qualifying children would be refund
Robin D : You are correct 13980 is low
Robin D : I think your colleagues are either envious of the overtime
Robin D : or
Robin D : truely miss the point
Customer: I compared my refund with a buddy with 2 kids, we have the exact same position, and his child credits seemed to give him a clear advantage. Although my rentals did a good job for me.
Robin D : And you can sale the rentals
Customer: I think they miss the point. You know how when a lot of people gossip about something, and people begin to believe comments that are not even true, but they believe it because so many people say it? I think that is the environment here.
Robin D : :)
Customer: The cautionary word I hear most from colleagues goes something like "if you work too much, you will go into the next tax bracket". But my thought is "fine. Put me into the next bracket. I will pay a slightly higher rate for all earnings that go into that bracket". Isn't that correct?
Robin D : Yes
Customer: I wish I could earn $250,000 per year, and would gladly pay the taxes on that.
Robin D : and when you do the math it is not really as dire as people think
Robin D : Amen
Customer: It may be more money for uncle sam, yes. But it is also a heck of a lot more money in your own pocket.
Customer: yes, I did the math and that is the conclusion I came to.
Robin D : It is not so much what one makes as much as the source of the income. No sword is one edged
Robin D : those individuals most probably do not understand their pension either
Customer: can you restate that sentence (about the sword), I want to make sure I understand exactly your point.
Robin D : Income is taxed but not all income is taxed the same. There is tax on earned income and unearned income
Robin D : That is why you receive a good deal with the rental property and the deductions you are allowed to use
Robin D : Also, employees are allowed to make sure a good bit of their income is removed from tax
Robin D : The pension contributions (401K) and benefits like chilcare and medical
Robin D : can be pretaxed amounts
Robin D : so those are not taxed for income
Customer: by the way, speaking of medical...
Robin D : Yes
Customer: I'm curious if I'm leaving any money on the table with regard to medical exemptions. What exactly is allowed to claim for medical expenditures
Customer: i have never claimed anything medical on a tax return.
Robin D : Medical care expenses include payments for the diagnosis, cure, mitigation, treatment, or prevention of disease, or payments for treatments affecting any structure or function of the body.
Robin D : You may never have gone over the 7.5% of your Adjusted Gross income on medical
Customer: ok, thats what I needed to know.
Robin D : That is why you would look to pretaxed medical Flex palns at work
Customer: 7.5 of adjusted gross
Customer: i don't go over that amount
Robin D : So Schedule A medical would not help you
Robin D : but
Robin D : Flexi account for medical may
Customer: so on 100,000 AGI, I would have had to pay 7,500 out of pocket for medical expenses.
Robin D : Yes
Customer: not even close
Robin D : any amount over the $7500 would be used on the Schedule A
Robin D : A Medical Flexible Spending Account (FSA) is an IRS-approved, tax-exempt account that saves you valuable tax dollars on eligible medical expenses. Each pay period, an amount of money that you have specified is deducted from your gross pay before federal income, Social Security, and Medicare taxes are calculated.
Robin D : As you incur eligible medical expenses, you may request withdrawals from your account to reimburse yourself for out-of-pocket expenses incurred by submitting a claim form with your bills to Human resources
Robin D : This is a way to use medical without having to be limited by your 7.5%
Robin D : You have to be accurate though
Robin D : because what you do not use you lose
Customer: I'm being audited right now for 2011 return. :(
Robin D : So sorry
Customer: my tax man says it is because of my rentals. (6 properties)
Robin D : Could be
Customer: He told me they are going after rentals right now.
Robin D : I have noticed more rental property audits
Customer: May I get your opinion about one more thing regarding this audit.
Robin D : Ok
Customer: I am going to lose on the audit because we are going to surrender on one major issue. It has to do with declaring as a real estate professional. For a few years in the past, we have claimed me as a "real estate professional" because I did the hands on management duties. But apparently, the guideline is 750 hours per year of hands on is what makes you a professional, and I no longer do that. I hired a management co. So I can no longer claim most of the deductions for repairs and such IN THE YEAR THEY OCCUR. So I will be giving some money back on that basis. Plus, I will be penalized a fine of perhaps 20%. That 20% penalty, if imposed on me, sticks in my craw because I believe that my tax team should have foreseen this situation and stopped me from making that claim. I feel they are as culpable as I am and should probably share that expense with me.
Robin D : They would be responsible for interest and penalties but they can request the penalties be abated
Robin D : Some big firms will reimburse for all
Customer: what is abated?
Robin D : Push for what you want. Abated is IRS speak for forgiven
Robin D : I guess forgiven is not in their vocabulary
Customer: hehe. right
Robin D : I hope this has been helpful
Customer: personally, I might pay the penalty in exchange for them not opening other years!
Robin D : They will place a penalty no matter
Robin D : The penalty will be for late payment because it was due back when filed
Robin D : I was happy to CHAT with you today
Customer: thanks for your info. I think I got what I needed.
Robin D : Your positive rating is always thanks enough.
Robin D : If you could also participate in the very short survey that Just Answer will send you by e-mail I would appreciate that very much.
Customer: ok, will do
Robin D : When you visit your question homepage, you’ll see a link to request me again. This link displays and works whether I am online or offline.
Customer: i will look for that
Robin D : Best wishes
Robin D : Thanks