You Must Pay Taxes–But There’s No Law That Says You Have to Leave a Tip

Although “tax time” may be over for this year, it’s never too early to start thinking about the taxes you’ll owe on your earnings for 2010. There’s a common feeling among federal employees that they won’t be affected by the expiration of the Bush tax cuts on December 31, 2010. Tax increases are only supposed to affect those earning more than $250,000, right?

However, if Congress does not pass further legislation this year, everyone will see their tax bracket and effective tax rates increase due to the Bush tax cuts expiring.

For the “average” middle income married federal employee (consider a dual income family), your top tax bracket could go from 25% to 31% next year simply due to the rollback of the Bush-era tax cuts. 

Let’s take a closer look. When talking about tax rates, you look at the adjusted gross income from your tax return and see where that income level falls within the tax brackets. For example, a married couple, filing jointly who make $150,000 are considered to be in the 28% bracket.

That, however, doesn’t tell the whole story. 

Our sample couple above, doesn’t pay 28% federal tax on all of their income – only on the income above $137,300. The first $16,750 of income has taxes calculated at 10%, the next $51,250 of income pays a tax rate of 15%, the next $69,300 has taxes paid at 25%, and finally, everything above $137,300 has tax calculated at 28%. The average of these taxes provides your effective tax rate, which in this case is 20.22%.

If Congress does not act to prevent the Bush tax cuts from reverting to the 2000 tax tables, our same federal couple earning $150,000 in adjusted gross income in 2011, will have an effective tax rate of 25.08%—a 24% increase! They will pay an additional $7,294 in taxes.

In addition, taxes will increase in several areas such as the capital gains tax increasing from 15% to 20% and the Medicare tax being applied to investments in certain areas.

There’s no time like the present to take advantage of the current tax rates if you have traditional IRA’s or other tax-qualified accounts that could be converted to a Roth IRA under this year’s lower rates. 

If you have capital gains in your non-IRA brokerage accounts, you may want to consider whether liquidating some stocks and mutual funds makes sense while the capital gains tax rate is still at 15%.

With reasonable planning techniques, you can manage your fair share of taxes and still have a little change in your pocket. If you would like a copy of a comparison of current tax rates and expected rates for 2011 and 2013, click here to download your free copy.