40: Understanding the US Progressive Tax System & Your W2 Income

Well, the one thing that I would say is the real big factor on people understanding their taxes is that you said before let's just say if someone makes $50,000. Okay, and it's a single person. Most people think that if they make $50,000, that say you're in the 22% tax bracket for Federal taxes. They think that the entire $50,000 is taxed at 22% is it not? It is not.

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Let's get started, hey babe, what are we talking about today?

Today we are talking about how your income is taxed, because the reality is and I think most people think that their income is taxed in one lump sum. What do you think? No, I would definitely agree.

I would say when I ask people and I ask this question With everyone that I work with do you understand how you are taxed on your income? And majority of the time is like I kind of do and I'm like I say this is the same space, there's no dumb questions. This is an area where, if you don't understand, it's perfectly fine to say that you don't, that you can learn. They're like and I want to say I don't necessarily understand and I don't listen minority people I think it's the majority people do not understand how our tax system works and how that correlates to how their tax on their income. For the sake of making this conversation easy, we're only talking about W2 income.

Okay, so how does it work? All right. So, first and foremost, you.

We need to understand that our tax system is a progressive tax system. What that means is is that as you make more money, certain dollars are taxed At a higher percentage. So the more money you make, technically, the more taxes, the higher you are taxed on. Okay, progressive tax.

Okay, progressive tax system. Yes got it, what else?

Well, the one thing that I would say is the real big factor on people understanding their taxes is, as you said before, let's just say if someone makes $50,000. Okay, and it's a single person. Most people think that if they make $50,000, that say you're in the 22% tax bracket for Federal taxes. They think that the entire $50,000 is taxed at 22%.

Is it not?

it is not.

Okay, so what does that mean?

So, as a single person for 2023, if your gross income and the money that you are being paid prior to taxes is $50,000, the first zero dollar to 11,000 dollars is taxed at 10%.

Zero to 11,000 dollars is taxed at 10%.

Yes, okay now any dollar over 11,000, so at 11,001 All the way up to 44,725, you are taxed 12%.

Okay, so we're like going in a tiered system.

Progressive.

Progressive Got it.

All right Now any dollar that you make above $44,725,. You are now taxed at 22%.

Okay.

So what that means is that most, like I said before, most people will think that the entire $50,000 was taxed at 22%, when in reality, only about a little over $5,000 was taxed at 22%.

Okay, so that's in our benefit then 100%.

It's a. Mathematically it's a huge difference.

So when people are like, oh, I'm getting a raise but it's going to push me into the next tax bracket, I should ask for different benefits because I don't want to be in that next tax bracket. Really, that tells us two things. One, they don't understand how their money is being taxed. And two, you should always take the raise.

Yeah, I've heard people say this a numerous times, so, like as I, using the tax brackets before you know. Let's just say, as a single person, you were making $44,000. All right, so I would put you in the highest tax bracket of your money being taxed at 12%. Let's just say you got a raise for $2,000. So it made you at $46,000. Some people think now that their entire paycheck is going to be taxed at 22% and it's all over, just an additional $2,000 that was added to their income, and that's not correct at all. Always take the raise.

Always take the raise.

Even if it pushes you into the next tax bracket. Only that small percentage that is above and to the next tax bracket is taxed at the higher percentage.

Okay, so what about the people making six figures? Let's say you're making $110,000. Can you talk to us about what that looks like on the tax scale, the progressive tax scale?

Yeah, so as an individual, you know, as a single person, it's still the same kind of the same principles we already talked about. So the first zero to $11,000 is taxed at 10%, the next $11,000 to $44,725 is taxed at 12%, and then the next $44,726, all the way up to $95,375, is taxed at 22%.

Okay.

Now the additional amount is taxed at 24% and that tax bracket goes from $95,376,000 to $182,100.

Okay, so $182,100 is that next level of that tax bracket?

Now here's where you kind of hear people saying that taxes are quote unquote. Maybe semi unfair is that if you see there are, you know, the tax brackets that we just went over, the margin of the tax bracket is not necessarily large. However, when you jump up to the highest federal tax bracket, which is 37%, it's anyone who makes $578,126 or more.

Or more.

So that's like an endless amount of money. Exactly.

Okay, that's really interesting. So what is it?

$578,126 as a single individual. Is this 37% tax bracket that amount and higher?

So then, if I'm making $4.2 million, I'm still in that tax bracket.

Correct.

Compared to somebody who's making the 538,000. Correct, that's a very large.

But here's the thing, and you know, like I said, I don't want to get too, you know, into the weeds, since we were mainly talking about W2 income. But majority of times, once you start to make that amount of money, normally you're not just a W2 employee.

And you're yeah, Okay, let's not.

And those can be taxed in different manners. Okay, but for the sake of the conversation, we want to talk about W2 employees. You know, most people that are working for someone else as a full time employee.

Okay, so a progressive tax system your entire paycheck is not taxed at the same amount. There are different tiers, if you will, of your paycheck being taxed at various amounts, and you should always take the raise.

Yeah, and the thing is too you need to understand how you are paid and how much you are paid. If I understand, that could be a little bit more difficult if you know you're self-employed on your own business of that nature because the amount that you're paid on a monthly basis fluctuates. But if you are a W-2 employee and you do not know how much you are making either each pay period or each month, that's a problem, because it should be the same amount you know, outside of bonuses and commissions and stuff like that, your base pay. You should 100% know and understand and that is one of the first steps in financial planning how much money do you have coming in?

But you've even said that you've asked people and your clients how much do you make? And a lot of times people can't answer that.

Yeah.

So you're going to work 40 plus hours a week, likely for somebody else. If you're not an entrepreneur and you don't know what you're working for, that's a problem.

It's also a red fly, because that already tells me that you're not organized, and you're not paying attention If you don't know how much money you make, when I would say that so much of this world revolves around money and how much you make and what you're able to do, and you can't answer that simple question. I'm pretty certain that there's other things that aren't in order and definitely need some work and focus.

All right, but it's not a bad thing.

I'm not here to shame anybody, but be real about who you are as a person and understand where you need to have some improvements.

We're not talking about all that today. Today, we're just talking about the tax brackets and understanding that your income is taxed at multiple levels in a progressive way, and you should always take the raise. I'm going to stop there.

I'm just going to add one extra thing. That's why I do that With knowing your income as well. You also need to understand how your income affects your eligibility for other things. Mainly, you always hear people talking about a Roth IRA. There are income limitations to contributing in the normal manner to a Roth IRA. There are alternative ways to utilize a Roth IRA. If you are above the income levels, if you have already reached above the maximum level of income to participate in the normal way, there are alternative ways to do that. But you need to know this because if you make more than you, if you have a higher income than what's allowed for the normal way to contribute to a Roth IRA and you do contribute to a Roth IRA, you're going to be penalized. I've been saying that because I always see on social media Roth IRA, roth IRA, roth IRA, great. But you need to also make sure that you are eligible to use it in the normal fashion.

Because I don't look good in orange. You're not going to go to jail.

You're just going to have a financial penalty.

Well, I don't want that either.

Exactly. Why throw away money if you don't have to?

Okay, we'll save that for another episode.

But end of the day.

You see how he always wants to weave everything together. Everything rolls into the other parts, which, yes, is why financial planning is so important, but I just wanted to talk about tax brackets today and he just won't. Let me be great, y'all, I'm done. Okay, hopefully you learned something. Share this episode with a friend, because most people don't know this information. Talk to you soon, don't forget. Benjamin Franklin said an investment in knowledge pays the best interest. You just got paid Until next time. Thanks for listening to today's episode. We are so glad to have you as part of our Sugar Daddy community. If you learned something today, please remember to subscribe, rate, review and share this episode with your friends, family and extended network. Don't forget to connect with us on social media at the Sugar Daddy podcast. You can also email us your questions you want us to answer for our past the sugar segments at the sugar daddy podcast at gmailcom, or leave us a voicemail through our Instagram.

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