For anything or service you buy, always consider what those items cost on an after tax basis as that will help you determine how hard you had to work for it. That being said, there are many different types of taxes that you most likely pay. They can include federal and state government, property taxes, city or local, FICA (for Medicare and Social Security), as well as others. All those costs add up and take out a big chunk of your “gross” pay.
What this means is that when you have a certain income (whether hourly wage or annual salary), you do not actually take home that amount of money each pay period or year. If someone makes say $30 an hour (or $1200 per week), they do not have $1200 available to them each week. They need to pay most of the taxes listed below. By the time all of that is done, maybe they are “taking home” $800 or $900 or so. Then of course they may be hit by annual taxes including real estate or dividends/capital gains. It is something that should also be part of budgeting for your household.
It is always important to think about taxes as part of budgeting as well as improving your financial literacy. It may be one of the biggest expenses you or anyone needs to make so it is important to understand that they are. As you are paying the various government agencies a lot of money each week, month, and year for taxes. Not only that, but there may also be other deductions in your paycheck that are not related to tax, but that still cost you money. They may include supplemental insurance, FSA accounts, and many others. Find paycheck deduction examples.
Types of taxes
Federal Government income taxes – The Internal Revenue Service creates tax brackets each year, based on the filers income. These brackets contain ranges of income, in dollars, and show the percentage of your taxable income you must pay in federal income tax for that income bracket. It is a progressive system, in that the more money you make the more money you will need to pay in that higher bracket. In simple terms, your income tax rate depends on how much money you make.
There are multiple progressive income tax brackets that range from 10% to 37%. Tax brackets change each year, so look yours up. Or they can change when Congress or the President makes changes to policies. It takes minutes to find the current tax brackets through an online search. This is the biggest chunk of your income that simply disappears. But the point is, that you need to factor in the amount you pay to the federal government as you try to determine what a true cost of buying shopping is.
Don’t confuse tax with withholdings as they are completely different concepts. Withholdings are an estimate of what you need to set aside for federal income taxes. Your actual tax could be slightly higher or lower. There are also other taxes besides income tax that the federal government requires you to pay, and they are noted below.
FICA – The federal government levies other taxes on your income but doesn’t call these income taxes. The main one is FICA. “FICA” stands for the Federal Insurance Contributions Act. It is really a program that pays for federal government benefits. FICA taxes go to both social security retirement funding and Medicare. The rate is 6.2% of your income. It is twice that if you are self-employed.
This rate only applies to the first $137,700 of your income, but that will increase each year. You don’t pay FICA taxes on any amount above that threshold.
Many people mistakenly think your social security contributions go into a personal account the government maintains for you, and that you get that money back when you retire. In reality, you are paying for someone else’s retirement now, and the hope is that by the time you retire, younger earners will pay for your retirement. This is not a guarantee.
However, for our purposes of thinking about shopping and buying stuff on an after income basis, it is important to know that right now a percentage of your income is taken out for social security and Medicare taxes. This percentage does not go up with your income level. But if you are buying something for $1000 and make $25 per hour, you still need to work more than 40 hours (and will need to work closer to 50 hours), to account for FICA as well as the other income taxes noted above.
Capital Gains Tax – This is a tax on sales of your investments. When you sell stocks bonds mutual funds, ETFs, or real estate for a profit, you may owe tax on that profit. When someone who is cashing in investments, or maybe a senior citizen living on retirement funds, they need to think about capital gains when really considering how much something costs in after tax dollars.
Capital gains tax only applies to long-term investments (those held over a year). Short-term gains are taxed at your income tax rate. Your capital gains rate depends on your income.
• If your income is at or below $40,000 ($80,000 for couples) you pay 0% capital gains tax.
• An income of between 40,001 and $441,500 incurs a 15% capital gains tax. (The figures for couples are $80,001 to $496,600.)
• Above $441,000 ($496,600 for couples) you will pay 20%.
Note that the income level you use for determining your capital gains tax rate is based on your total income including wages. This means that when buying something, or taking a trick or doing other spending, if you are living off capital gains (or using it to supplement your income), then that will need to be considered when factoring in how many hours you need to work on an after tax basis. However, the capital gains tax only applies to investments you have sold for a profit.
Tax on your investment income does not occur regularly, because it only applies when you sell an asset, so only use this figure if selling investments is a regular source of income for you. Even after selling it you only need to pay capital gains on an annual basis at the time you file your federal return.
State Tax – Most states have an income tax. Each state sets its own rates and tax brackets, so you have to find the one that fits your location. This goes into the example above when determining the cost of sending you do on an after tax basis. State tax rates range from 2.9% to 13.3%. Forty-one states tax wages, while New Hampshire and Tennessee only tax dividends. H
The challenge with state income tax is that each state sets not only its own rates, but also its own income brackets. Some states charge a flat tax-the same amount for all wage earners. If you earn income in two states that have an income tax, you have to pay tax on the portions of income for each state. State income tax is not as complicated as it sounds. Simply find the tax rate in your location and don’t worry about the rest.
States with no income tax include Texas, Washington, Alaska, Florida, Nevada, South Dakota, and Wyoming. But they will often have other fees. While understanding financial literacy means understanding all taxes (state, income, FIVCA, sales, etc,.), you can use state calculations as an exercise in itself when determining after tax cost of spending. As if an item you are shopping for, say a Video Game, costs $50 and you make $25 per hour and your states tax rate is 10%, then you will need to earn $55 to pay for that video game. As that would be $55 then pay over $5.50 at the 10% tax rate.
Sales Tax – Not all states have sales tax on purchases, but for those that do, the rate is between 2.9% and 7.25% of the cost of each purchase. The dollar amount can vary widely based on how many purchases you make, so it is hard to calculate. Some people do add up all the sales tax they have paid from receipts as part of a budgeting process.
The problem with this is when you buy with a debit card or credit card, you only see the final amount of the purchase and can’t see how much of it was sales tax. However, if you have a monthly budget, you can estimate your sales tax based on the total number of expenditures.
It can be a good idea to track your sales tax for a couple of months, then come up with an average percentage of your income you are paying. This can give you a better picture of where your paycheck is going.
Local Taxes – Many cities have income taxes or some other fee or tax, which also need to be factors in when calculated the true after tax cost of your monthly spending or buying something on a one-off basis. These tax percentages are smaller than state tax levels though and not all cities charge them. Usually they are collected with the state tax, and authorities portion them out between the state and your city.
You should ask what your local tax rate is, because you may have been paying it with your state taxes and might not be aware of the percentage. That number is also needed to calculate how many hours you need to work to buy items for your or your family.
Your city may levy a flat rate, such as 2% on all income, or it may ask for a flat dollar amount, such as two dollars per week. Other localities may charge tax according to your income bracket. Larger cities often have higher rates.
Property or real estate taxes are also charged locally. These are usually based on income though. Instead the amount is based on the assessed value of your property (or some formula your municipality comes up with) and go to fund local schools or local government. While this may not be an income tax, it is still money out of your pocket and affects your purchasing power.
Average your past property taxes to come up with a percentage of your income that typically goes to property taxes. When checking for your rate, check to see if property tax is a state tax in your locality. You may miss it by thinking it is only a local tax.
Taxes are a major expense to budget for
While the exact amount of taxes that people pay varies based on where they live, their income tax brackets, property value, and other factors it is almost always a major expense. In fact, when you think about hard or how many hours you need to work in order to buy something, always be mindful of the taxes too. As you will always need to work longer and harder to account for annual taxes.
By Jon McNamara