A new college graduate with a starting salary of $40,000 can expect to pay about $8,000 in taxes. While your actual tax bill varies by state and personal circumstances (for example, having kids makes a big difference), the question for novice earners remains – Why?!
Your income tax bill has five key components: federal, Social Security, Medicare, state, and local taxes. It’s confusing partly because only two of these – Social Security and Medicare – are fixed amounts. Every worker in every state pays a tax of 6.2% for Social Security and 1.45% for Medicare.
The remaining three taxes – federal, state, and local – vary widely. Here is a brief look at the two factors most likely to affect your tax bill.
Location, location, location! In the United States, you pay zero state income tax if you live in Texas, Florida, Washington, Nevada, South Dakota, Wyoming and Alaska. The remaining 43 states have an income tax, but rates vary. Pennsylvania, Indiana and North Dakota charge under 4%, while California has the highest marginal tax rate in the country at 13.3%.
Does that mean Pennsylvania is a good deal? Not so fast. Towns in Pennsylvania charge a local tax. Philadelphia’s local tax is near 4%.
The second big factor affecting your tax bill is how much you earn. The federal government and 33 states use a “bracket” system. Your tax rate rises as your income increases.
If you google “2021 federal tax brackets,” you’ll find that all taxpayers fall into one of seven brackets. While twentysomethings won’t panic over the first two (10% and 12%, respectively), it only takes adjusted gross income of $40,525 to land in the 22% bracket.
Once you are in the 22% bracket or higher, you can lose 40% of your income to taxes because you still have to pay social security, medicare, state, and, possibly, local taxes.
Does anyone really lose 40% of income to taxes? Only someone who is really, really clueless.
Smart people use legal tax shelters like 401(k)s to divert income away from the taxman and toward their goals like saving for retirement.
But that is a topic for another time. Here’s hoping you prosper enough to want to know more.
Gerald Whittaker runs Whitt Accounts, LLC. He is a member of the National Association of Tax Preparers.
Kristen Jacks is the Founder of Money in Your Twenties. Click here to view Kristen Jacks’ bio.
To learn more about the book Money in Your Twenties click here.