- Let me summarize our discussion of income taxes.
First, there is the notion of the tax bracket.
Income is taxed in chunks.
The first part of income in almost
every tax system around the world
is not taxed at all.
So this is a 0% tax bracket.
Income higher than this initial amount
is chopped up into pieces, tax brackets.
Income in higher tax brackets
is typically taxed at higher rates.
Income in the lower tax brackets
is never taxed at the higher rates
that apply to income in the higher tax brackets.
We also discussed the notion of the average tax rate,
and the marginal tax rate.
The average tax rate is computed
as the tax that you pay divided
by how much income you made.
The average federal tax rate in the United States
for individuals is somewhere between 10% and 15%.
The marginal tax rate is the rate
that you're going to pay on the next dollar
of income that you make.
Economists say that the marginal rate
is a very important rate, because
that's the rate that people have
in mind as they consider, should I work harder
and make more money, because the marginal rate
is what I will have to pay on that additional money
if I make it.
We saw the difference between
a tax deduction and a tax credit.
If you spend money on a tax deductible item,
you don't have to pay tax on the income
you used to pay for that item.
A tax credit, on the other hand,
is granted when money is spent
in a way that is so favored by the government
that the government will say, if you spend
money in a certain way, that's the same
as our spending money in that same way.
Your taxes go down directly by an amount
equal to what you spent on that tax credit item.
A tax credit is more valuable
to you in a sense than a tax deduction.
We discussed the difference between
ordinary income and capital gains income.
The most important thing to remember
from a tax standpoint is that capital gains
income is taxed at a lower rate.
Ordinary income is most of the income
with which you and I are familiar,
wages, salaries, and interest on savings accounts.
Capital gains income is income
from increases in the value of investments.
The increased amount is called capital gains income,
and you typically pay a lower income tax rate
on capital gains.
As a result, many tax shelters
are designed to classify income,
not as ordinary income, but as capital gains income.
Overriding everything with respect
to income taxes is this, there are precise
rules set down by the government where you live,
and your objective in income tax accounting
is following those rules so that you comply with the law.
You want to pay all the tax that you owe.
Now it is certainly a legitimate thing
to plan your affairs to pay the minimum tax
allowable under the law, but you want
to make sure that you obey the rules
and pay the tax that you owe.