The Story Behind the Story

August 19, 2011

Thanks to Heidi for her question about providing links to the information supporting my last article, The Real Job Creators. I appreciate you setting a good example as all of us should be making sure our sources have facts on which to base their conclusions.

For many of the facts and figures, I didn’t provide a link because in many cases the information is in a specific section of a long document. In the case of the take home pay amounts at different tax rates, there is a calculation process involved in determining these amounts.

For those who want to see the sources and calculations, I am happy to share. Enjoy!

Of course, if you don’t need this information or aren’t interested, don’t feel like you need to torture yourself scrolling through reports or reviewing lengthy math calculations.

Links To Sources

Top tax rate income level
On page 6 of this IRS document you will find the income levels for all current tax brackets.

Small business owner information
According to the Center on Budget and Policy Priorities, only 2% of small business owner earn a salary that places them in the top tax brackets (see figure 2)

Additional sources on typical small business incomes from:
The Houston Chronicle, eHow.com and Gather.com.

Top tax rate during final year of Clinton Administration
2000 tax rates (PDF)

How to calculate taxes at different income levels

Income Tax Infographic

One misconception that people have about calculating total federal taxes is that your entire income is taxed at your highest bracket rate. For example, a friend of mine immediately whipped out his calculator and said if I take $450,000 x 35%, that will tell me how much federal tax he owes. This is not correct. It is much more complicated.

Our income is taxed differently at each income level. For those who are married filing jointly, they pay 10% on the first $17,000, 15% on additional taxable income up to $69,000, 25% on additional up to $139,350, 28% on additional up to $212,300, 33% on additional up to $379,150, and 35% on anything at or above $379,151.

The calculation process for the small business owner making $450,000

Although I could have only calculated the total federal tax, subtracted it from the total, and divided by 12 for a monthly estimate, this would not give us a true take home pay because it does not include state tax, social security, and medicare withholdings. I used PaycheckCity.com to calculate an estimate of the true take home pay.

Please keep in mind that the precise take home pay amounts under the current tax code will vary slightly from state to state depending on the state income tax rate. However, what does not change is the amount of the federal tax increase if you move from 35% to 39.6%.

I’ll walk through an example to help illustrate the point. Since Wisconsin has been in the news lately, I’ll use them as an example:

Go to PaycheckCity.com and select Wisconsin
Gross Pay: $450,000 Annually
Pay Frequency: Monthly
Federal Filing Status: Married
and 4 exemptions for both federal and state…

We find that our example small business owner would have a monthly net take home pay of $22,766. (Of course, this is slightly different from the $23,144 from my state because of the different state tax rates)

Again, the top income bracket begins at $379,151 so to calculate the tax difference at 39.6% for the top bracket, we use the following calculations:

  • Amount of current income taxed at 35% = $450,000 – $379,151 = $70,849
  • $70,849 × 35% = $24,797 current tax paid on income above 379,151
  • $70,849 × 39.6% = $28,056 amount that would be paid on this income at 39.6% rate
  • $28,056 – $24,797 = $3,259 yearly difference
  • $3,259 ÷ 12 = $272 monthly difference (exactly the same as in my example)
  • $22,766 (35% take home) – $272 (monthly difference) = $22,494 (39.6% take home)

Yearly take home pay for single person making $30,000

To calculate the yearly take home pay for single person making $30,000, we go to PaycheckCity and enter Wisconsin, $30,000 Annually, Monthly pay, Single, 1 exemption. This gives us a monthly take home pay of $ 1,959. So, the yearly take home pay = $ 1,959 X 12 = $23,058. This is similar albeit slightly more than the monthly take home above.

Calculating the yearly take home increase with a 25% top tax rate

To calculate the increase in monthly take home pay at a lower 25% top income tax rate we go through the following calculations:

  • $70,849 × 35% = $24,797 current tax paid on income above 379,151
  • $70,849 × 25% = $17,712 amount of tax that would be paid at 25% rate
  • $24,797 – $17,712 = $7,085 increase in yearly take home income

Clear as mud? If not, feel free to ask questions in the comments or contact me here.