Don't Mess With Taxes

With all the attention on Occupy Wall Street tax protests, which Americans make up the richest 1 percent and growing income disparity, the timing of the Internal Revenue Service's annual inflation adjustments couldn't be better.

Each year about this time, the IRS looks at official inflation data and then calculates how increases, if any, in the cost of living will apply to a wide variety of tax provisions that affect almost every taxpayer.

The changes include standard deduction and personal exemption amounts, how much money we can sock away in retirement accounts, the value of popular tax credits and, of course, how much of our income will fall into what income tax brackets.

Since, as I mentioned, income is a major focus right now, today's Weekly Tax Tip is a preview of how your 2012 earnings will be taxed.

Marginal vs. effective taxes: It's always fun to look at tax tables -- hey, you're the one reading a tax blog! -- but remember that just because your overall income falls into a certain tax bracket, you won't end up paying taxes at just your top rate.

Despite all the talk about flat taxes by Republican presidential nominee wannabes, right now our tax system still is progressive. That means the amount of income taxes you pay increases as you make more money.

These increases occur in steps. So even if a single taxpayer makes $50,000 in 2012, she's not going to owe the IRS $12,500, or 25 percent of her income since her top earnings amount is in the 25 percent income tax bracket.

Her first $8,700 as a single taxpayer is taxed at 10 percent. The next $26,650 at 15 percent and then the final $14,650 of her income taxed at her top rate of 25 percent.

That makes her tax bill $8,530 instead of $12,500. Here's the down-and-dirty math:

$8,700 x 10 percent = $870
$26,650 x 15 percent = $3,997.50
$14,650 x 25 percent = $3,662.50

And $870 + $3,997.50 + $3,662.50 = $8,530

The progressive tax brackets mean our hypothetical taxpayer's IRS bill is $3,970 less that it would have been if all her money was taxed at her final 25 percent rate.

And that makes her actual, effective or average (pick your term) tax rate on the $50,000 just 16.7 percent even though her marginal tax rate, which is the rate applied to the last dollar of income she earned, is 25 percent.

Remember, too, that my very simple, for-illustration-purposes-only example uses our fake filer's $50,000 gross earnings, not her final taxable income amount.

She'll owe even less once her total income amount is reduced by adjustments, deductions and exemptions that she can claim.

More numbers on the way: Keep in mind that these income tax tables apply to your 2012 income. They have no bearing on your 2011 tax return that you will file next year. My earlier post on the 2011 tax brackets will  help you with that task.

But they are useful for tax planning. So if you're one of those annoyingly organized and obsessive taxpayers, have fun.

As for the rest of the IRS inflation figures -- and there are a lot of them; 21 printed pages to be precise, plus a separate announcement on pension plans -- I'm working on putting that data into special blog pages and will post them as soon as I finish.

You also might find these items of interest:

• Social Security benefits increase in 2012
• 10 states with the highest income tax rates
• Today's taxes aren't too bad