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1 Federal Taxes

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2 Taxable Income and How Much You Owe – Your Tax Liability In the notes here I will show an example about the tax liability for a person based on filling in the year 2003 and the filer is single. Plus I will assume income amounts are only in whole dollars, no change. Lastly, I will only consider taxable income. The federal government changes the tax system from time to time but they use the same basic structure and principals. On the next slide I have a fish bowl – yes a fish bowl. Think of income earned in the year as water filling up the bowl. The first dollars earned stay at the bottom and then additional dollars pile on top. Think of the hose pumping in the water as staying on top of the water level and rising as the level rising.

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3 Income rangeTax rate Over $311,95035% 143,501 to 311,950 33% 68,801 to 143,50028% 28,401 to 68,80025% 7,001 to 28,40015% 1 to 7,00010%

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4 Example of Tax Liability for a person earning $312,000 in a year Note on the previous slide the water line is up to about $312,000 Steps to calculate the tax. 1. Find what level of the fish bowl the yearly income ends “up” in. Call this “zlevel”. 2. Take the final income amount and subtract the high water mark of the next lowest level. 3. Take the result of step 2 and multiple the rate in zlevel. 4. Take all the income in all levels below zlevel and multiple each income amount by the corresponding tax rate. 5. The tax liability is the sum of findings in steps3&4. Hey Billy, DYK All $’s of income earned are not taxed at the same rate?

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5 Steps 1 through 3 mean (312,000 – 311,950).35 = 17.50 then we have steps 4& 5 (311,950 – 143,500).33 = 55588.50, and (143,500 – 68,800).28 = 20916, and (68,800 – 28,400).25 = 10100, and (28,400 – 7000).15 = 3210, and (7000 – 0).10 = 700. Then adding all the numbers to the right of the equal signs we get a grand total of (if I did all of the math correctly) 90,532 The marginal tax rate The example above had the individual with 312,000 of income. Their last dollar earned was taxed at 35 %.. We say then that this individual is in the 35% tax bracket.

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6 The marginal tax rate is the rate on the last dollar earned. If an individual had only 100,000 in income then the marginal tax rate would be 28%. The average tax rate The average tax rate is simply the fraction tax liability/taxable income. The lady with income 312,000 has an average tax of 96475.4/300000 =.29 So the lady with 312,000 is in the 35% bracket and paid on average 29% of her income in income tax. Remember, some $’s were taxed at 10%, some 15% and so on. So the average for her was 29%.

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7 Bracket Creep You may recall that inflation is the general increase in prices. It seems to be the case that many get an increase in income each year while inflation is happening. If the income rises in percentage terms as much as the inflation, then the individual can buy all the same stuff and be as well off in the second year. Say someone has taxable income just at the top level of a given bracket. Then their income in the new year pushes them into a higher bracket. Since on the additional $’s are taxed at a greater %, maybe the individual can not beat the inflation rate and is then worse off. To overcome the creeping into higher tax brackets and the negative impact inflation has on the income that is left, the income levels in each tax bracket have been indexed to inflation.

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8 Indexed to inflation means that the income levels in the tax brackets are changed each year by the inflation rate. This way if an individual’s income gain is not as high in percentage terms as the rate of inflation, then they will not be kicked up into a higher tax bracket and have the tax bracket change “penalize” them with lower purchasing power. The Marriage Penalty Say two people are single and file separate tax returns. If they get married and both continue to work there is a scenario where if they file a joint return as a married couple with the same income they could end up with having to pay more in tax. The basic logic is the joint return pushes them into a higher bracket and thus some of their dollars together are taxed at a higher rate than their dollars separate.

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