Many of you recently enjoyed the NCAA basketball tournament and all the fun that comes with filling out your brackets and then watching them be demolished because the whole point of March Madness is that you can’t ever predict which unheralded 12-seed will upset a favorite, or guess who this year’s Cinderella team will be and whether they will get all the way to the Final Four.

And I said “…you recently enjoyed….” most deliberately, because March Madness comes, inconveniently, right in the middle of the heaviest part of tax season, a brutal slog of sixteen-hour days wherein I never get to bed before 2:00 a.m. , and do not have anything remotely like the luxury of stopping to watch even a single basketball game, much less two whole weeks of them. You may have enjoyed watching the tournament, but I haven’t seen it in years, sad to say.

So to make up for it, I’m going to address my own kind of bracketology this month, the kind that has to do with how much income you earn and what percentage of tax you have to pay on it. And don’t roll your eyes! I know it isn’t as scintillating as top-level college basketball, but judging by the number of people who ask me what tax bracket they are in, and how pleasantly surprised most of them are when I tell them what percentage of their gross income they actually pay as income tax, this is something most of you wonder about at one time or another.

Before we begin, let me point out that the tax brackets are never the same from one year to the next (come to think of it, neither are the NCAA brackets!). Where each of them begins and ends is adjusted each year to keep up with the cost of living—the tax brackets, that is. How the brackets for March Madness are determined cannot really be understood by anybody, as far as I can tell!

In addition, Congress recently changed the makeup of the tax brackets themselves—what they call the marginal tax rates--for the first time since 2003. Back then, they were laid out as follows: 10%, 15%, 25%, 28%, 33% and 35%. However, beginning in 2013, a seventh bracket of 39.6% was added (or more correctly, the 2003 law that eliminated it was allowed to expire).

Now, people sometimes look at those brackets in horror and think, “Ohmigosh! Are they taking 40% of what I earn?” Or 35%? Or 33%? Or 28%?

And the answer to that is a resounding “No!” Nothing near it.

First of all, nobody ever pays tax on 100% of their income. At the very least, everyone is entitled to a standard deduction, meaning a standard amount of income is deducted from their gross earnings before the tax is calculated. How much that deduction is depends on their filing status: married, single, head of household (a topic for another day), but it reduces the amount of their taxable income, sometimes by a substantial amount. If they have enough of the right kinds of expenses (usually mortgage interest, state income taxes, property taxes, charitable donations; sometimes medical expenses or unreimbursed job expenses), they might instead be entitled to claim itemized deductions, which can sometimes be double or more what the standard deduction would be.

Then, in addition to their standard or itemized deductions, every taxpayer is entitled to a personal exemption, also inflation-adjusted, for each person in the household. For 2013, the exemption was $3,900. That means an additional amount is considered exempt from taxation, and for a married couple with, let’s say, four kids that adds up to $23,400 excluded from income before it is taxed. Not bad!

So, let’s take a closer look at those tax brackets. For 2013, the income amounts spread between each bracket for a married couple filing jointly went like this:
• 10% = $0 to $17,850
• 15% = $17,851 to $72,500
• 25% = $72,501 to $146,400
• 28% = $146,401 to $233,050
• 33% = $233,051 to $398,350
• 35% = $398,351 to $450,000
• 39.6% = Over $450,000

Most of you look at those brackets and the first thing you realize is that you don’t earn anywhere near the money that it takes to be in the highest three or four brackets. But if you and your wife earn, say, $110,000 per year, you still recoil to think that 25% of your income is sucked away as income tax.

But don’t forget about the standard and itemized deductions, and the personal exemption. Your taxable income is nowhere near that $110K.

For one real-life couple this year, a truck driver and a school teacher, here’s what actually happened. Something similar probably happened to you, regardless of your occupation, regardless of your filing status, and to some extent, regardless of your income.

For this couple—let’s call them Robert and Marianne—their combined gross income came to $89,635. That would put them solidly in the 25% tax bracket, if (and it’s a big “if”) that was their taxable income. But first, they were able to adjust their income down by $250 in educator expenses and $655 in student loan interest, so their adjusted gross income was only $88,730 (sorry, I didn’t mention adjustments, some of which “adjust” income up and some of which “adjust” it down).

Next, they were able to claim $19,795 in itemized deductions, most of that amount being state and local taxes and mortgage interest paid. That far exceeded the standard deduction for a married couple filing jointly in 2013 of $12,200. Voila, their reportable income is down to only $68,935—not even in the 25% bracket anymore!

Then, with two dependent children living at home, that’s four exemptions at $3,900 each, or an additional $19,500 they were allowed to subtract. And with that calculation we have finally arrived at their taxable income: $48,435. Solidly in the 15% tax bracket, and very nearly half of their gross income for 2013!

But even now, we aren’t done. Is all that taxable income taxed at 15%? No. Only the amount that exceeds $17,850. Any amount under that threshold is only taxed at 10%. That’s the grand secret most people don’t understand! All taxpayers are taxed at their highest marginal rate only for the portion of their income that falls within that bracket. In effect, they slide through all the underlying brackets before they reach that rate. So for a physician client of mine whose taxable income, even after deductions, was well over $300,000, his first $17,850 was taxed at 10%. His next $54,649 was taxed at 15%; his next $73,899 was taxed at 25%, and his next $86,649 was taxed at 28%. Only his last portion of income was taxed at 33%, his nominal tax rate. His effective tax rate, meaning the actual amount of tax he paid after all deductions and credits, and after sliding through all the underlying tax brackets, was 23.6%.

What was Robert and Marianne’s effective tax rate? After claiming the child tax credit for their two dependents (also didn’t talk about credits), it was a mere 5%. Chances are, you are a lot like them.

So that’s bracketology to a tax guy, and geek that I am, I find it fascinating. I often take a minute when I’m going over a return with a client to quickly explain how it all works and then calculate their effective tax rate before their very eyes. Almost without exception, they are pleased and amazed.

Would you like to know what your effective tax rate is? Find the amount of actual tax you paid (on Form 1040 that would generally be line 55) and divide it by your adjusted gross income (line 38). Or call me at 801-635-9609. I think you’ll also be amazed!

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