How Your Income is Taxed
Exemptions, Deductions & Then Your Tax Brackets
Not all of your income is taxed. Your income is reduced by various exemptions and deductions, discussed below, to arrive at your “taxable income.”
The average family pays 15% of income in federal income & payroll taxes.
Your “taxable income” is then divided into different brackets, with the taxes you pay rising from 10% on the first $17,000 of taxable income (less if single, or a single head of household with at least one dependent child) to 39.6% on any taxable income above $400,000 (single individual filers) to $450,000 (married couples filing jointly).
Marginal Tax Rates –
Taxes on Different Brackets of Taxable Income: 2013
Tax Rate | Married Filing Jointly | Single Individual | Head of Household |
| 10% | First $17,850 | First $8,925 | $12,750 |
| 15% | $17,850 to $72,500 | $8,925 to $36,250 | $12,700 to $48,600 |
| 25% | $72,500 to $146,400 | $36,250 to $87,850 | $48,600 to $125,450 |
| 28% | $146,400 to $223,050 | $87,850 to $183,250 | $125,450 to $203,150 |
| 33% | $223,050 to $398,350 | $183,250 to $398,350 | $203,150 to $398,350 |
| 35% | $398,350 to $450,000 | $398,350 to $400,000 | $398,350 to $425,000 |
| 39.6% | Over $450,000 | Over $400,000 | Over $425,000 |
Some investment income is taxed differently
- Dividends and long-term capital gains (profits from selling stocks, bonds, and other investments held a year or more) are taxed up to 20%, depending on your tax bracket.
- For households with Adjusted Gross Income above $250,000 ($200,000 for individuals), interest, dividends, rents, annuities, royalties, and capital gains greater than $500,000 ($250,000 for individuals) are taxed an additional 3.8%.
Uncle Sam is Your Partner
Incentives to "Do the Right Thing"
The tax code includes exemptions and deductions, which reduce the amount of income subject to taxation. They are incentives to do the “right thing.”
They encourage you to:
- Own your home. You can deduct mortgage interest you pay and reduce your taxable income.
- Save for retirement. Investment income in 401(k), 403(b), and IRA retirement savings accounts is exempt from taxation. You can also deduct contributions to “traditional” 401(k)s, 403(b)s, and IRAs and pay tax on amounts taken out in retirement, when your tax rate is usually lower. For more, see Learn More About IRAs and 401(k)s.
- Get insurance. You can deduct “pre-tax” contributions to employer-provided health and group insurance plans and health spending accounts; the investment income in whole life insurance policies is also exempt from taxation.
- Invest in education. You can deduct the interest you pay on qualified student loans and the investment income in “529” college savings accounts is exempt from taxation.
- Give to charity. You can deduct your contributions to charity.
Not all exemptions and deductions are incentives.
- Some are designed to increase “fairness.” Most important are:
- Personal exemptions, $3,900 in 2013, phased out for those with high incomes.
- The standard deduction, $6,100 in 2013, $12,200 for married couples.
- Deductions for child-care expenses.
- Some are due to Constitutional limitations, such as deductions for state and local taxes and the exclusion of interest income paid by state and local bonds.
The Social Security Payroll Tax
It's the largest tax most of us pay
The Social Security payroll tax is a tax on earnings – wages, salaries, and tips. The tax entitles you and your family to benefits that replace those earnings when you retire, become disabled, or die, and to Medicare benefits at age 65. The tax is:
- 7.65% of your earnings up to $113,700 ($110,100 in 2012) and 1.45% on earnings above that amount, with the $113,700 “earnings cap” rising each year in line with the growth in national average earnings.
- Matched by your employer – or by you if you’re self-employed – an additional 7.65% on earnings up to the earnings cap and 1.45% on earnings above the cap.
Special Rules in Retirement
Taxes on Social Security Benefits & IRA Savings
At most, only some of your Social Security benefits are taxed. How much of your benefits are taxed depends on your Combined Income, defined as the sum of:
- Half of your annual Social Security benefits.
- Your adjusted gross income (your income less many, but not all, of the deductions and exemptions used to calculate your taxable income) not including your Social Security benefits.
- Interest income you get from state or local government bonds that is not taxed by the federal government.
Percent of benefits taxed based on your marital status and Combined Income
| % Taxed | Married | Single |
|---|---|---|
| None | Less than $32,000 | Less than $25,000 |
| Up to 50% | $32,000-$44,000 | $25,000-$34,000 |
| Up to 85% | More than $44,000 | More than $34,000 |
At least some of your IRA/401(k) savings will be taxed. You have already paid tax on income contributed to “Roth” accounts, and your savings in these accounts won’t be taxed again. But beginning at age 70 ½, you must make Required Minimum Distributions from “traditional” 401(k)s, 403(b)s, and IRAs – so the government can tax what you have in these accounts.
- The Required Minimum Distributions are set percentages of your savings in these accounts based on age, rising from 3.6% in the year you turn 70½ to 11.6% when you’re 95.
- Note that you don’t have to spend what you take out. You could also save the after-tax amount.
