Copyright © 2008, The McGraw-Hill Companies, Inc.
Ta x RateZoe’s Income Subject
to RateZoe’s Tax on This
Income10% (up to $7,550) $7,550 $755.00
15% (from $7,550 to $30,650) $23,100 $3,465.00
25% (from $30,650 to $74,200) $12,350 $3,087.50
To tal $43,000 $7,307.50Notice that the total tax on the first two rows adds up to $4,090.00, the amount from the tax
table. This is where the “$4,090.00 plus 25%” in the tax table comes from. Since anyone
in the 25% bracket will have these same tax rates applied to his first $30,650 of income,
instead of calculating the tax in this detail over and over again, the table just gives the
“$4,220.00 plus 25%” formula. This also helps avoid any confusion over whether the 25%
rate applies to all income of just some of it.
Notice that even though Luisa and Alfonso’s taxable income was larger than Zoe’s,
they are in a lower tax bracket and pay less in tax than Zoe did as a single taxpayer. This
is because their income is combined, and the tax rates that apply to married couples have
higher cutoffs for each tax bracket to reflect this fact. Nonetheless, it is often the case that,
overall, a married couple winds up paying more in taxes filing jointly than they would have
as individuals, particularly if both spouses have income from employment. This is some-
times referred to as the marriage penalty. However, this is not always the case. If Luisa
(or Alfonso) does not work outside the home and most or all of their combined income is
earned by one person, they may end up paying quite a bit less in tax that they would have
as individuals.
There are some other details that may affect the overall amount of tax owed. The rates
given above apply to income from most sources, referred to as ordinary income. Certain
types of income, however, may be taxed at different rates. For example, income from
capital gains (the profit from selling stocks or other investments at a higher price than
paid) may be taxed at a lower rate than ordinary income; there is also currently a lower tax
rate for dividends paid to stockholders. Also, once the tax is calculated, the amount of tax
may be reduced by special tax credits. Tax credits are offered for families with children, for
child care expenses, for adoption expenses, for buying a hybrid car, and many other things.
The specific items for which tax credits are offered, and the requirements for being able to
claim those credits, change frequently.
There has been much discussion in the news over the last few years of the alternative
minimum tax, or AMT. The AMT is an alternative way of calculating the income tax
due, one that uses different rates and does not allow for as many tax deductions as the
usual formula. If the amount a taxpayer would owe under the AMT is larger, that is the
amount of tax that must be paid. The AMT was originally intended to make sure that
very high income taxpayers did not avoid paying income taxes by taking unusually large
tax deductions. Unfortunately, the dollar amounts specified by the law were not adjusted
for inflation, and as prices have risen over time incomes that were once considered very
high and deductions that were once unusually large are no longer so high or unusual.
The AMT now affects many more taxpayers than it was originally intended to. Because
of the complexity involved, and because the rules for the AMT are likely to change
over the next few years, our discussion of this topic will be limited to mentioning its
existence.
State income taxes are generally calculated in much the same way as federal taxes,
except that the various states have different rates, and may have different rules for
dependent exemptions and what items are and are not deductible. Some states mirror
the federal rules quite closely, while others may differ in significant ways. Also, while
most states use progressive tax rates, there are several states (including, as of this writing,
Colorado, Indiana, Illinois, Massachusetts, Michigan, and Pennsylvania) that employ a flat
state income tax rate.9.2 Income and Payroll Taxes 389