- All right, let's talk about income taxes,
income tax accounting is its own specialized field.
With income tax accounting, there's an important element
there's an important elementof income tax compliance,
of income tax compliance, you have to make sure
you have to make sure thatyou are obeying the law.
that you're obeying the law, there's also an element
There's also an elementof income tax planning,
of income tax planning, meaning that you want to try
meaning that you want to tryto structure your affairs
to structure your affairs so you don't have
so that you don't haveto pay anymore income tax
to pay any more income tax than you are legally required
than you are legally required to pay.
to pay and of course for you and me,
And of course for you and me
there's just a routine element
of filling out your income tax form each year.
your income tax form each year.
To facilitate our discussion of income tax systems,
To facilitate our discussionof income tax systems
I have designed a very simple income tax system
that contains the important elements
of all income tax systems around the world
and this simple system for income from zero to $50,
In this simple system forincome from $0 to $5$0
you don't pay any income tax at all.
you don't pay any income tax at all, you are allowed to make
You are allowed to makethat money tax free.
that money tax free.
While this feature is common in governmental tax systems
in governmental taxsystems around the world.
around the world, in my system for all income above $50,
In my system, for all income above $5$0
the tax rate is 5$0%,
the tax rate is 50%,
it's going to make our calculations much more simple.
that's going to make ourcalculations much more simple.
Now we can accurately usethis simple tax system
Now we can accurately use this simple tax system
to represent systems in place around the world.
Using this simple tax system, we'll answer these questions.
Using this simple tax systemwe'll answer these questions.
How much tax would you pay if you made $50 in income.
What if you made $51?
What if you made a $100?
What if you made a $1000?
Let's do the computations in each one of those four cases.
Let's do the computations ineach one of those four cases.
If you make $50, you don't pay any income tax at all
income tax at all under this system.
under this system, the first $50 of income is tax free
The first $5$0 of income is tax free.
so that was pretty easy, that was an easy computation to do.
that was an easy computation to do.
All right but what if you make $51?
Okay, now on the first $50, you still pay no tax.
Okay now on the first$5$0 you still pay no tax.
On that 51st dollar, you pay tax at the rate of 50%
On that 51st dollar you paytax at the rate of 5$0%.
so your total tax is half a dollar or 50 cents.
So your total tax ishalf a dollar or $$0.5$0.
This computation illustrates the important notion
This computation illustrates
the important notion of the tax bracket.
of the tax bracket.
You'll hear sometimes people sadly report,
You'll hear sometimes people sadly report
"Oh, I've got a raise so now I'm in a higher tax bracket."
"Oh I got a raise so now I'min a higher tax bracket."
Well that's a naive comment and I'll show you why.
and I'll show you why.
The first tax bracket in this case is from zero to $50
and the rate on that first $50 is always zero,
no matter how much you make so when you make the 51st dollar
So when you make the 51st dollar
and move up into the next tax bracket, the new rate
the new rate of 5$0% isnot applied retroactively,
of 50% is not applied retroactively, you don't have
you don't have to go backand pay the 5$0% rate
to go back and pay the 50% rate on the first $50,
on the first $5$0, thatfirst $5$0 is never taxed.
that first $50 is never taxed.
Going to the next tax bracketdoes not cost you any money,
Going to the next tax bracket does not cost you any money,
it just means you have to pay a different rate
on the extra income that you're going to make
so don't be afraid of making more money and going
So don't be afraid of making more money
and going into the next tax bracket,
into the next tax bracket, instead,
instead a raise is alwaysa cause for celebration.
a raise is always a cause for celebration.
Now under this simple tax system, how much tax do you pay
Now under this simple tax system,
how much tax do youpay if you make $1$0$0?
if you make a $100?
Well again the first $50 is never taxed
Well again, the first $5$0 is never taxed
so the tax that you pay is $0.
so the tax that you pay is zero.
The second $50 is taxed at the rate of 50%
The second $5$0 istaxed at a rate of 5$0%,
so you're going to pay a total of $25 tax
if your taxable income is a $100 and if you make a $1000,
And if you make $1,$0$0$0, well again
well again the first $50 is not taxed,
the first $5$0 is not taxed,
the remaining $95$0 istaxed at the rate of 5$0%.
the remaining $950 is taxed at the rate of 50%
so you'll pay a total of $475 tax
So you'll pay a total of $475 tax
if your taxable income $1000.
if your taxable income is $1,$0$0$0.
This simple system shows how tax brackets
and tax rates are used to determine
and tax rates are used to determine the amount
the amount of tax you should pay.
of tax you should pay.