How Does Our Tax System Work | What You Need To Know In Order To Understand How You Are Taxed

Troy Sharpe: Do you understand how our tax system works? Well, I wouldn’t blame you if you don’t because it’s a very complex system, and in this video, I’m going to lay out the basics to help you understand how your dollars are taxed.

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Hi, I’m Troy Sharpe, CEO of Oak Harvest Financial Group, CERTIFIED FINANCIAL PLANNER™ Professional (CFP®), and host of The Retirement Income Show. We have a progressive tax system in the United States of America. This means as you progressively earn more money, your dollars are taxed at higher rates. Everyone pays the same income tax level in the first tier, in the second tier, and in the third tier and so on, but as you make more income and move down those tiers, you pay more income tax.

These are the 2020 tax brackets. First thing we have to do is identify are you single or are you married? The first tax bracket is 10%. We’re going to look at married filing jointly, so it’s this column over here. All dollars up to 19,750 are taxed at 10%. It doesn’t matter if you make a million dollars a year or you make 20,000 a year, those dollars are taxed at 10%.

The next bracket is 12%. If you earn money between 19,751 and 80,250, those dollars in that range, they’re taxed at 12%. Oftentimes people will say, “Troy, I’m in the 24% bracket” and a lot of times they’ll think that that means they pick 24% on all of their income. It’s not true. We have a progressive tax system. That’s the first thing to understand. Now, these numbers here are based on what’s known as your taxable income.

To get to your taxable income, this is not exact, this is a simplified version of this, but you’re going to look at all of your income. Your W-2, if you have commissions, if you have any type of consulting fees, anything like that. All of your wages counts towards your income. If you’re self-employed, you may have some deductions here beyond the standard deduction, but the simplified version here, look at all your income, subtract out your deductions to get to your taxable income.

If you’re single, you get to subtract 12,400 from your income to get to your taxable income. If you’re married filing jointly, 24,800. If you are over 65, each spouse gets an additional $1,650 deduction. Now, part of the Trump tax cuts increased all these deductions for everyone and got rid of the opportunity to have a lot of itemized deductions. I’m not going to go too deep into that because most people do not have itemized deductions that exceed these standard deductions.

We take our income, subtract our standard deductions, this gets us to our taxable income. Once we have our taxable income the dollars in this range here, if you’re married filing jointly, up to 19,750y are taxed at 10%, between this range taxed at 12, between this range taxed at 22, then 24. One thing to keep in mind here, with the Trump tax cuts, what happened was, not only did the rates go down but the brackets got wider. This means we’re paying lower rates, but also, you’re able to have more dollars inside these brackets taxed at lower rates.

This is why when we look at these tax brackets and we talk about how these tax cuts are going to expire in 2026, you’ve never had a better time to take money out of your retirement account, pay lower taxes today than in your entire lifetime. We need to understand how this system works because this is critically important to retirement planning, to personal financial planning, and this is something that we do every single day for our clients here at Oak Harvest Financial group because I believe you can’t be a fiduciary unless you’re looking out for your client’s best interest from not just an investment standpoint and a relationship standpoint, but also a tax perspective. We have to keep taxes down it’s a big part of the way to keep a lot of money in your pocket and not inside the government. Keep in mind this is just the income tax system.

Part of your income that goes into this calculation are also capital gains and dividends. Now, they’re usually taxed at a different rate, but keep in mind they do increase your income level which can increase your taxable income. Figuring out how this progressive tax system works is critically important to keeping more dollars in your pocket in retirement.

If you’d like our help in figuring this out, doing an analysis, you can reach out to us through the website, and there will be a link in the description down below where you can reach out to us there as well.

This is how our progressive tax system works, but these are not the only taxes that we pay. Keep in mind we have FICA taxes. FICA taxes, that’s money that comes out of your paycheck that goes towards social security and Medicare. You pay 7.65% on all of your wages and your employer pays an additional 7.65 on all of your wages to the government. The government gets 15.3%.

This caps out. It’s around about $140,000 of income for the social security part, but for your purposes, your wages you’re paying an additional 7.65% on all of them on top of your income tax. If you own property you pay property tax, every time we buy something in this country, we pay sales tax, and of course if you have investments and you have gains in those investments when they’re sold, you pay capital gains tax. A lot of different taxes here that we have to keep in mind when we’re planning for retirement.

This is a critical part to your personal retirement plan because of those big questions, “Do I have enough? Can I retire? How do I pay less tax? Will my family be okay if something happens to me?” This is a critical part to having the answers to those questions because the more money we keep and pay less tax, the more money we’re going to have as time goes on.

This is the primer on how our progressive tax system works in this country. Make sure to share this video with a friend or family member. Hit that thumbs up button, hit the subscribe button so we can keep you more connected to your money.

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