Episode 028: Q&A 13

On this episode, I answer the question “How much can I earn in order to not hit the next tax bracket?”

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Episode Transcript

Braden: (00:00)
Hello and welcome to episode 28 of the unfuck your biz podcasts. As always, I am your host, Brayden and today I am very excited to be tackling with you a tax question. So if you've been listening to the podcast for a minute, I apologize this beginning so it's going to be a little bit repetitive, but for those of you who are new, let me explain to you how Tuesday episodes work. I have a Facebook group called Brayden's besties would love for you to come join us over there. When you do a hop in the group it is going to prompt you to answer three questions. Question number one is for you to share one legal or tax question you have in your business. I collect all of those questions and every Tuesday here on the podcast we answer one. So the question we are going to answer today is how much can I earn including my full time job to not hit the next tax bracket?

Braden: (00:58)
So this is an interesting question for a few reasons and it's kind of one of those circumstances where I want to say it's really the wrong question. Of course, there's no such thing as a wrong question, right? But I'm going to explain to you why it doesn't really make sense. I'm not explaining this very well, but I understand what this individual is asking. But I'm going to explain to you kind of the breakdown of the tax, the tax rules that are implicated here and how they work. So again, the question is how much can I earn to not hit the next tax bracket? So what I want to do is start by explaining to you all how tax brackets operate. And I'm going to do this by actually going through an example, but I teach inside of my membership called fundamentals. This is actually reading off one or two of the slides in the lessons.

Braden: (01:52)
So tax brackets are calculated, um, through this example. Okay, so let's, let's assume that there are three tax brackets. So I'm going to oversimplify this to make it a little bit more digestible. Let's assume there are three tax brackets and that the tax bracket says that on income up to $10,000 the percentage is 10% at $50,000 the percentage is 15% and at $100,000 the percentage is 20% so when I read this question, the way I'm interpreting it is this person says, how much money can I earn to not hit the next bracket? So if they currently make $90,000, then the, the, um, quick understanding would be they want to know that once they make 10,000 more dollars, they're going to be taxed at the next tax bracket. Are you with me? Hopefully that's not too confusing, but, um, what I, what I, I can kind of read through the lines and I understand why they're asking this.

Braden: (02:55)
So a lot of people would assume the, once you go from the 15 to the 20% tax bracket and you're now making $100,000 the all your income is taxed at 20% and this individual might be thinking, I don't want to make a thousand more dollars and now be subject to a 20% tax because it's going to cost me more in taxes and lose me money. But that is not how this actually works. Okay? This is how it does work. So let's go back to our numbers. Let's assume our hypothetical, a question asked for here. Makes $110,000 let's go with that. The way our imaginary brackets work is that on their first $10,000 they're taxed at 10% so first $10,000 are taxed at 10% which would be $1,000 in taxes. You with me? And then income from a $10,001 to $50,000 is taxed at 15% that's that second bracket. So the second chunk of income is taxed at 15% and that would equal $60,000 so 15% of 40,000 which is the difference is $6,000 now we're saying that income up to a hundred thousand is taxed at 20% so but then packets are 50 to a hundred that bucket is taxed at 20% so that would equal 20% of $50,000 is 10,000 right?

Braden: (04:32)
And now let's just assume that there another rack that we were going to say on all income above a hundred thousand dollars are going to be taxed at 25% so their total income was 110,000 then we're taxing that $10,000 above 100,000 at 25% which would be $2,500 now, I probably should have done all this math before I started the episode, but I'm just going to do quick math here while we are live, and you can see this kind of magic. I'm going to work. So if we add up all these tax numbers, we get a total tax amount of 19,500 we divide 19,500 divided by 110,000 and we see that as 17.7% so the gist of this is is that the way tax brackets actually work is it divides your money into buckets. So I want you to literally think about all of the money you made last year and I want you to vision some of the money in cash, dollar bills sitting on one bucket and some of the cash in another bucket.

Braden: (05:37)
And actually picture like three to five buckets. The more money you made, the more buckets there are going to be. And the way taxes work is picture uncle Sam, we all know what he looks like and he's going to walk up to your buckets and say, I'm going to take 10% of all the money in your first bucket and I'm going to take 12% of the money in your second bucket and 16% of the money in your third bucket. And he gets all the way down to your seventh bucket and that is only going to have money in it. If you made, you know, in the millions of dollars, I think it's actually 1 million and then he's going to take 37 and a half percent of the money and that bucket. And that is how tax brackets work. So the question was how much money can I earn before I hit the next bracket?

Braden: (06:23)
And the answer is it depends on how much money you make, whether you're single or filed, married jointly because you're going to have different brackets. But I would argue that the question is not really important because it's a marginal tax rates like we just explained. So if my hypothetical tax payer made $110,000 on all that math we did, we determined that they owe 17.7% in tax despite the fact that they were in the 25% tax bracket. So we would call 17.7% their effective tax rate. That's how much tax they're actually paying on that total income. Please keep in mind that I just totally made up those tax percentages. They don't reflect the real life brackets. We just made them a lot simpler because in real life some of the brackets go to like 42,500. They're not simple numbers to calculate. Uh, but that's the breakdown.

Braden: (07:21)
I hope that this was helpful. I do live talks very often and I always explain how tax brackets work and them and I always do light bulb moments for people when they listen. Same thing when I teach life inside of my membership and my course, I always like to talk about this topic because it's very highly misunderstood and it's also just helpful to be a better citizen as well because when we hear top politicians arguing about it, we now understand the way it works. So about a year ago, I'm going off script. This podcast is going to be a little longer than our normal Tuesday ones, but I hope that's okay. So last year, AOC, Alec, Congresswoman Alexandra Ocasio Cortez, I apologize, have a hard time pronouncing her name as she proposed a 70% tax rate on the highest marginal tax bracket and what happens is this gets really blown out of proportion both by political opponents and by the media saying that this person wants to take 70% of your income, but she was proposing this I believe on income over $10 million a year and may have even been higher than that, but less than 1% of people and it's basically just once you hit seven or once you hit $10 million a year on all of the income above that, your tax is going to go up from 37% to 70% and that is a pretty big chunk, but it actually reflects what our tax percentages were basically from the great depression almost through the 1980s and I could ramble about that all day tax policy and we could all argue as to whether that's a good idea for policy, whether you know rich people should have to give up that much money in their taxes.

Braden: (09:00)
That is a personal decision. But what I think is really important is that we at least all understand how it works, because if we're well-informed, then we can make our decision as to what we agree with. So I hope that I answered the question today and made sense to all of you. It's a little bit difficult to teach that without the help of any visual AIDS, but I, uh, I hope it made sense and if you liked it, don't forget to subscribe and leave a review for the podcast. Join us in the Facebook group and I cannot wait to be back with you on the podcast this Thursday. And I hope that you have a great day.