Monday, April 16, 2012

Understanding why some people pay lower tax rates

By Rick Manning

The so-called “Buffett Rule” would automatically subject anyone who has taxable income above one million dollars to a 30 percent tax rate regardless of how that money was earned. But, it is based upon the hope that Americans fundamentally misunderstand the way different types of income are taxed and the reasons behind these differences.

The first question to ask is: Do those who make over a million dollars a year pay a lower income tax than those who make under that amount?

The answer is some do, and some don’t. It depends upon how they make their money.

If a single wage earner makes has taxable income equaling more than a million dollars in straight wages in 2011, then that person will pay $327,313 in federal taxes, or 32.7 percent of their income in taxes.

Yet, if the same person earns all of their money in capital gains from investments that (s)he owned form more than a year, the money is taxed at the lower rate of 15 percent, and the investor would owe $150,000.

And that is where the entire confusion over the ill-named “Buffett Rule” comes about. Most workers get a vast majority or all of their income from wages so they are taxed at a sliding scale rate depending upon the taxable income.

Whereas, it is not uncommon for people who make in excess of one million dollars of year in income to have much of that money a result of selling property or assets that they have owned for more than a year and their income is derived from the profit they made from the asset. These transactions are called long-term capital gains.

What is the difference between the two scenarios?

The person earning money through wages has not put any of his or her personal wealth at risk in order to gain a return, the straight wage earner is trading his/her time in exchange for money.
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