Tax Terms

It’s been a long time since April; perhaps you didn’t take along the Tax Code for summer reading on your vacation this year. Just in case, here’s a refresher:

Bracket

A grouping of income levels. Under current law (with the Bush tax cuts in place) there are six brackets, each with its own rate: 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, and 35 percent.

Rates (also called “marginal rates”)

The percentage of taxable income you are charged on your “last dollar.” Everybody pays the same rate on the same amount of taxable income. A high-income household would pay several different (graduated) rates.

For example, a married couple with $350,000 taxable income would pay 10 percent on their first $17,400, 15 percent on income between $17,401 and $70,700, 25 percent on income between $70,701 and $142,700, 28 percent on income between $142,701 and $217,450, and 33 percent on the rest of their income, up to $350,000. If their taxable income exceeded $388,350, they’d pay the top rate on those “last dollars” of 35 percent.

Taxable Income

Not every dollar deposited in your bank account from your employer or your business is “taxable income.” A number of items are subtracted, such as:

• The cost of earning that money – business expenses
• Personal exemptions – set amounts subtracted for each person in your household
• Standard deduction or itemized deductions – either a flat percentage that is subtracted (standard) or a list of deductions that you figure out yourself, including extraordinary medical expenses, taxes paid to other entities, interest on home mortgages and student loans, cost of child care, charitable giving and some expenses of volunteer work, among many other things.

So the person with $350,000 taxable income may in fact receive quite a bit more actual income.

Tax credits

Amounts that can be subtracted directly from your tax bill, once you’ve figured out how much you would owe. Some of the credits under scrutiny this fall will include a child tax credit, a child care tax credit, and the earned income tax credit.

Taxes on investments

In addition to taxes on money earned through employment or a business, there are also (generally lower) taxes on the money earned by your investments. Capital gains taxes apply to the increase in value of stocks or other assets that you sell. If you sell something within a year of acquiring it, the increase in value is taxed as ordinary income, according to your tax bracket. If you hold on to the asset for a year, it is a “long term capital gain.” There is no tax if you are in the 10 percent or 15 percent tax bracket, and a 15 percent tax if you are in a higher tax bracket. There are also taxes on dividends (from stock) and other types of investment income, which vary according to the instrument, the issuing body, and other factors.

“Marriage Penalty”

Many tax rules give an advantage to a married couple, compared to two people in similar circumstances who are not married. But some tax rules favor unmarried people, giving each person in a married couple less of a benefit than they would receive if they were not married. Before 2001, the earned income tax credit – focused on low-income workers – was an example. Two workers each earning $10,000 would qualify for the credit. But if they were married, they would have qualified for $4000 less than the two of them could have claimed as single people. President Obama’s tax proposal specifically addresses this “fix” – it would continue the provision in the “Bush tax cuts” that provided the same benefits to one-worker and two-worker low-income households.