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Just Explain It: Why taxes for most are rising while others don’t pay any federal income tax

Just Explain It

The fiscal cliff has been averted, but at a cost. Most Americans will pay higher taxes this year.

According to the Tax Policy Center, 77% of American households will face higher federal taxes in 2013.

“For almost all of them, the hike will be only in payroll tax,” says Roberton Williams, an economist at the Tax Policy Center. “The American Taxpayer Relief Act will boost federal taxes for just 0.7% of tax units. The new Obamacare taxes will hit a few more but overall, less than 2% of all tax units will see an income tax increase in 2013.”

Here’s how it breaks down. If you’re an individual making over $400,000 a year, or a family pulling in more than $450,000… the tax rate on your last dollars of taxable income will go up by almost 5 percentage points.

Every worker will see an increase in taxes. That’s because Congress let the payroll tax cut expire on December 31st. So for every $100 you earn in 2013, you’ll take home $2 less than you did last year.

The debate over taxes was a major part of last year’s presidential election. President Obama did what he said and raised taxes on the wealthy. The question of who should bear more of the tax burden was a hotly contested topic. Is our tax system fair? And are the wealthy asked to do more while others contribute nothing?

We’ll explore those questions and more in today’s Just Explain It.

It has often been quoted that almost half of Americans don’t pay federal income taxes. Is that true and who are they? Also, how can some of the wealthiest get by without paying any income tax at all?

Most Americans pay taxes in some form or another, but not everyone pays the federal income tax. Williams says “the income tax was set up in a way that allows people not to pay it by doing particular things.” He authored a report that found 46% of Americans in 2011 (47% in 2010) didn’t pay federal income tax because they took credits and deductions for things like, going to school, retirement savings plans, childcare and mortgages.

However, half of the people who don’t pay taxes have no taxable income. Williams says “their standard deduction and personal exemptions are at least as large as their total income, leaving them with no income subject to tax.”

Here’s a look at how a family might end up not paying any federal income taxes.

If a couple earning $51,000 with childcare expenses of three thousand dollars a year for their two kids under 13. At that income level, the family would have a basic tax liability of almost $2600.

But after standard deductions, credits for childcare, this family's net tax bill would be -$12. The family wouldn't have to pay federal income tax at all in 2012.

In certain cases wealthy Americans who earn over $1 million don’t have to pay federal income taxes either. For example, if your business losses offset positive income or, if you’re given credit for foreign taxes to avoid double taxation.

Billionaire investor Warren Buffett believes the rich don’t pay enough in taxes. Buffett said his 2010 tax bill was $6.9 million. That was about 17.4% of his income. Even though that’s a lot of money, he was taxed at a much lower rate than 20 other people in his office. An average of 36% of their income went to taxes.

If all of this seems complicated to you, you’re not alone. Income taxes have been a point of contention in this country since Abe Lincoln and Congress introduced them 150 years ago. About the only thing Americans agree on is that the tax code has to be simplified.

Did you learn something? Do you have a topic you’d like explained? Give us your feedback in the comments below or on Twitter using #justexplainit.

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