Money Rehab with Nicole Lapin - How Our Tax System Actually Works (For You)

Episode Date: June 24, 2021

The US tax system is designed to increase your tax burden as you grow wealth… which is how it should be, but it can feel like a major buzz-kill if you’re kicking a** and climbing the financial ladder. But if you’re jumping tax brackets, it’s not game over for your income! Tune in to learn how the US’ progressive tax system helps keep more money in our pockets, and why tax brackets are kind of like Russian stacking dolls. Learn more about your ad-choices at https://www.iheartpodcastnetwork.comSee omnystudio.com/listener for privacy information.

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Well, it doesn't. Charge for wasting our time. I will take a check. Like an old school truck. You recognize her from anchoring on CNN, CNBC, and Bloomberg. The only financial expert you don't need a dictionary to understand. Nicole Lappin. Today I'm answering a question that I get a lot.

It's a question about taxes. Yes, tax day has come and gone, and I bet you thought you were totally done-zo with taxes. Nope. Here they are. Back to haunt you. Today, taxes are rearing their ugly head yet again through a question from money rehabber Monique. Hey, Nicole, I want to ask for a raise, but I'm right on the edge of my tax bracket. And if I get a raise, I'm going to move into a higher bracket. Will I actually be making less money if I get taxed at a higher rate? To answer this question, we're going to have to take a deep dive

into the topic of the progressive tax system, which, yes, is the tax system here in the good old U.S. of A. And I always get questions on this topic. And most often these questions come up because I'll post something on Instagram and offhandedly mention progressive taxes, and it opens up the floodgates into my DMs. Yes, these are the sexy kind of flips into the DMs that I get. Don't be jelly. A lot of people don't know that we have a progressive tax system in the United States, or even what the heck that means. And if you're one of those people right now, well, you won't be at the end of this episode. There's a huge misconception about progressive taxes that I'm going to get into,

but first, a little bit of a setup. You may remember this snippet from my conversation with my accountant. What do you think right now? I mean, historically, you think our tax rate is high or low right now? Historically, our tax rate is low. That's, you know, that's not fair. I've asked you that before. No, you haven't. You look so much better. Yes, I have. No, no, no, no, no, because I just wrote a freaking book about this that I sent you. I. Yes, I have. No, no, no, no, no. Because I just wrote a freaking book about this that I sent you. I'm not sure I agree with that. You that I didn't tell you. But anyways, you are correct. So the highest tax rates ever been in this country is 94 percent. And if you go back to, you know, 1913 and and take the top tax rate from every year from 1913 through last year and average them together,

our average tax rate, top tax rate in this country is 60%. We're 37 right now. So historically, we're at a really low rate. This may feel surprising to you, but yes, the tax rates right now are historically low and especially low for those making the least amount of money. The U.S. tax system is set up to impose higher taxes on for those making the least amount of money. The U.S. tax system is set up to impose higher taxes on the Americans making the most income. Whether or not you feel like the wealthiest Americans are being taxed too much or not enough is a different question. But regardless, it is true that the tax system in the United States is set up so that Americans earning the most income are taxed at the highest rate. That system

was built by creating tax brackets. Tax brackets are ranges of income set up by the U.S. government that get taxed at different rates. For example, the first tax bracket for unmarried folks is defined as the income range between $0 and $9,875. The tax rate for that income range is 10%. The second tax bracket is for the income range between $0 and $40,125. And the rate for that tax bracket is 12%, and so on. Not every tax model in the United States is progressive. For example, a sales tax is flat, meaning regardless of income, everyone pays the same rate of sales tax. In recent years, the U.S. tax system has gotten less progressive. In 2021, there are seven tax brackets with the rates of 10, 12, 22, 24, 32, 35, and 37% respectively.

A little over 30 years ago, there were 16 tax brackets though. I won't go through the income cutoffs for each tax bracket because even though we now only have seven tax brackets, that's still a lot of numbers and that doesn't necessarily help our full understanding of how the system actually works. Instead, I'll just use one example. Hold on to your wallets, boys and girls.

Money rehab will be right back. Now for some more money rehab. According to the U.S. Census Bureau, the median household income was $68,703 in 2019. It has changed, of course, but let's assume that it hasn't changed very much. So for easy math, let's take a look at what you're paying in taxes if you're making $60,000 a year. You may Google, I make $60,000 a year, what tax bracket am I in? And you'll see that you're in the third tax bracket. People who make under $85,525, to be exact, are in this third tax bracket where the tax rate is 22%. Here comes the big reveal. This is the part that so, so many people get wrong.

If Google tells you that you're in this third tax bracket, you may think that that means the total amount of your income is getting taxed at 22%. At $60,000 a year, that means you're paying $13,200 in taxes. And yikes, that is a lot of freaking lattes for Uncle Sam. Thinking about tax rates this way is flat out straight up wrong. The progressive tax system means that not all of your income is taxed at the same rate. Instead, your income gets grouped into the national tax brackets, and each of these little chunks of your income are taxed at the corresponding rate. I'm going to give you a conceptual explanation,

and then we're going to look at that $60,000 example we were just playing with. Okay, so you're just going to have to trust me on this one, but you know those Russian nesting dolls? If you don't, there are those wooden hollow dolls that sack on top of each other so that as you open them, you find a doll within a doll within a doll. within a doll. Honestly, not really a good sandbox activity. It's not that fun. But anyway, the U.S. tax system is a lot like a Russian doll. But instead of dolls, there are tax brackets within tax brackets within tax brackets. And each tax bracket has a different tax rate. When you're figuring out how much income tax you'll be paying, it's like you're stacking these dolls and how many dolls you get to stack depends

on how much income you have. If you're making $60,000 a year and you are in the third tax bracket, that means that nested inside your income is the second tax bracket and the first tax bracket too, right? So when you pay taxes, you're paying the tax rate associated with each doll as you're building your stack up. Yes, I know I just said that nesting dolls are not the most fun sandbox game, and now I'm saying that you have to pay taxes as part of this game, you're probably thinking, this game sucks. But just hear me out. Here come the numbers. Remember I told you that the first tax bracket is defined as income up to $9,875, and it's taxed at a 10% rate? So for your $60,000 a year income, you'd pay 10% on the first $9,875. Then we stack the

next nesting doll, which is the second tax bracket, with a 12% tax rate on everything up to $40,125. But wait, you've already paid taxes on the first income tax bracket and you don't have to pay taxes on that twice. Thank God. So essentially what you're going to do is take your second bracket of income and subtract what you've already paid taxes on. So that's $40,125. The second tax bracket minus $9,875. The first tax bracket, or $30,250. That's the amount of money you're paying 12% tax on. Let's stack our next tax bracket. The third tax bracket is for income up to $85,525 and is taxed at a 22% rate. And since we're saying you're making $60,000, you're going to get taxed 22% on $60,000 minus the second tax bracket. When you do the math, which I did, but I will not

make you do, it brings your grand total to $8,990. And that is what you owe in taxes. That's a lot better than the $13,200 you thought you were paying before you understood what it actually meant to have a progressive tax model. For today's tip, you can take straight to the bank. Don't worry about losing money by getting a raise. Monique, accept the raise. Thanks to our progressive tax system, you will still be making more money, but you'll just be taxed a little bit higher, which is a rich bitch problem to have. Money Rehab is a production of iHeartMedia. I'm your host, Nicole Lappin. Our producers are Morgan Lavoie and Catherine Law.

Money Rehab is edited and engineered by Brandon Dickert with help from Josh Fisher. Executive producers are Mangesh Hatikader and Will Pearson. Huge thanks to the OG Money Rehab supervising producer, Michelle Lanz, for her pre-production and development work. And as always, thanks to you for finally investing in yourself so that you can get it together and get it all.