- A simplified breakdown of how the US tax system works
- What is a progressive tax and how does it affect what I pay?
What is Progressive Tax?
A progressive tax is based upon a taxpayer’s ability to pay; it imposes a lower tax rate on low earners as opposed to higher earners who are “progressively” taxed more, according to their income. In the United States, the progressive tax system is based on tax brackets.
What Are Tax Brackets?
Tax brackets are based on the amount of taxable income individuals make. They act as cutoff values that determine what percent of your income can be taxed, depending on single or joint filing status.
Without brackets, there would be a flat tax rate, a regressive tax, which would mean the same percentage of income is taxed no matter the amount earned. Biden and Yellen’s IRA and 401k tax proposals are examples of flat taxes.
Progressive Tax: Good or Bad?
Progressive taxes are typically favored because they reduce the tax burden on low earners. On the contrary, those who oppose a progressive tax structure feel that high tax rates instill a sense of complacency from citizens and “punish” high earners.
Progressive vs. Regressive Taxes
- Progressive — Investment Income Taxes: Obamacare levies a 3.8% net investment income tax that applies only to individuals who earn over $200,000 a year ($250,000 for joint filings).
- Regressive — Social Security Tax: Social security tax is paid at the same rate no matter the income level. All employees pay 6.2%, and it is matched by employers for a 12.4% total.
Taxable Income vs. Gross Income
In the US, citizens are only taxed upon their taxable income, also known as Adjusted Gross Income (AGI).
- Gross Income: Total amount paid to an employee by the employer before taxes and other deductions.
- Taxable Income: Portion of gross income that is subject to taxation in the U.S. Taxable income is equal to gross income (including wages, salaries, bonuses, and tips) minus deductions. Also includes the appreciation of any assets that have been sold during the year.
The US taxation system is complex and constantly evolving—that’s why taxpayers need a trusted financial advisor. Call DSJCPA at 516-541-6549 to speak to a tax professional and visit our website for a full list of our services.