Even though I’m a CPA, I totally get it: tax is that three letter word that causes most Americans to break out into hives or magically compels them want to run away.
The complicated (and ever changing) tax laws in the U.S. definitely don’t help! It’s no surprise then that there a lot of misconceptions surrounding your income taxes, about tax loopholes, and about taxes in general.
Stay with me here – this post will be busting three common myths on tax that you may have heard.
If you get a raise that pushes you to the next tax bracket, that means you will be taking home less money.
Please do not turn down a raise or a promotion because of the incorrect idea that you will be bringing home less money.
Let me say it again louder for the people in the back.
Don’t. Turn. Down. More. Money.
In the U.S., we have a progressive tax system of marginal tax rates. That means that we are taxed on our income in graduated buckets. The common belief is that as you make higher income and move into a higher tax bracket, your entire income is taxed at the higher tax rate.
This is false.
Only the portion of wages that fall within that higher bracket are taxed at the higher tax rate. So when you get that next raise, please don’t let this myth rain on your parade. Instead, celebrate!
Getting married means that you and your spouse will definitely see tax benefits
If you and your partner are getting hitched, congratulations!
There are many possible benefits to getting married for those who choose to make that very personal decision. But when it comes to whether the two of you will enjoy what is known as the “marriage benefit” or a “marriage bonus” in tax, the answer is: it depends.
Generally speaking, the marriage benefit arises with two people with very different incomes.
The addition of the lower income to the higher income is usually not enough to make enough waves to push the overall income into the higher tax bracket. Because married couples enjoy a wider tax bracket than that for an individual, most of that combined income falls within a lower tax bracket.
But this is generally not true with couples who make around the same income.
With two incomes that are more or less the same, the combined income is doubled. Unfortunately, although married couples enjoy wider tax brackets, the tax brackets are not twice as large. Combined, more of their income will fall in a higher tax bracket, than as individuals facing the tax brackets of a single person.
You are getting taxed more on your bonuses than on your regular paycheck
Let’s squash this one right now: bonuses are not taxed at a higher rate than your regular paycheck.
There are two scenarios that arise with supplemental income, such as bonuses (sign on bonuses, performance bonuses, referral bonuses, etc), severance, and commissions.
In the first scenario, your bonus is added to your regular on cycle paycheck. The payroll system assumes that this is your regular pay for the period and estimates your annual pay accordingly. Your taxes would be withheld as if the total was your regular rate for the period.
If the bonus is paid out in an off cycle paycheck, then it will be subject to federal withholding at a flat 22% rate. The amount withheld is not the same as the taxes paid.
The difference lies within the structure of the payout – at the end of the day, your total tax bill will be the same.
So the key takeaway of all of this is…
The thought of taxes can really give people a headache.
It can be dry, complicated, and not exactly engaging dinner conversation material with friends where you can share tips and knowledge.
But it’s important to put to rest some common tax myths that can influence you to make suboptimal financial decisions.
Don’t forget – tax is a key part of financial planning considerations and growing your wealth!