Everyone who has an income is, or should be, familiar with Federal income tax. Federal income taxes became a permanent part of the history for the United States in 1913. There are two sources of income to be taxed: earned income and unearned income. Earned income would consist of wages, salaries and tips, either paid to you by an employer or earned by being self employed. Interest, dividend and capital gains are considered unearned income. The different types of income are taxed at different rates. Individuals that have a larger percent of their income as unearned income pay a lower tax rate percentage in comparison to an individual if it was earned income.
Earned income is taxed at a progressive rate: the higher the income, the higher the tax rate. These rates are 10%, 15%, 25%, 28%, 33% and 35% for the calendar year 2011. This income is also subject to payroll taxes. For the year 2011, one of the payroll taxes is on the first $106,800 and this is social security tax. This is called Old-Age, Survivors, and Disability Insurance (OASDI) tax and is taxed at a rate of 6.2%. Another payroll tax is Medicare Health Insurance (HI) and is on the entire earned income, but at a rate of 1.45%. Additionally these two taxes are matched by the employer. Individuals who are self-employed must pay both portions of the payroll tax at the same rates. However during 2011 and extended to 2012, there was a payroll tax break on the employee part of the social security tax and was reduced to 4.2%.
The capital gains, dividend and interest income, being classified as unearned income, are taxed at a lower rate than earned income because they are not subjected to the payroll tax. In addition capital gains have preferential tax treatment and are taxed at alternative rates. For example, the capital gain is taxed at 0% for the 10% and 15% Federal tax rate brackets and 15% for the Federal tax rate brackets above 15%. This tax rate is changing after 2012, when the 15% will be rising to 20%. The capital gains are taxed at a preferential rate in theory to increase investor activity and capital investments. Furthermore with respect to interest and dividends, some interest income is not subjected to tax at all, and some types of dividend income have preferential tax treatment. For example, interest income from state and local bonds is not taxed, and qualified dividends have the same preferential tax treatment as capital gains.
Individuals with higher total income pay a lower tax percentage because of this preferential tax treatment structure on capital gains, dividends and interest income. The lower tax percentage is also due to the social security payroll tax being limited to the first $106,800 of earned income. The higher income individuals often have a salary along with stock options and dividends. Due to preferential tax rates on the latter as unearned income, they tend to have a lower percentage of taxes paid to the Federal government. This being the case, some individuals often prefer to receive their income as unearned. For example, a billionaire that makes over $40 million a year pays a little less than $7 million in taxes; this is a tax rate at a little over 17%. Most of this income is taxed at a rate of 15% because the majority of income is capital gains. Other the other hand an individual making a salary of $50,000 a year generally cannot afford, nor is often offered, to take stock options instead of wages. With the lower income salary, the salary that individual earns, he or she will usually need it to sustain daily living expenses.
Due to the different types of income and the rates at which they are taxed, there is a preferential tax treatment to those that have more income, especially when that income is both earned and unearned. The individuals that earn a smaller earned income are additionally subjected to payroll taxes and thus results in usually higher total tax percentage. Individuals that have a combined income of both earned and unearned income pay a lower percentage than those who would take the same amount only as earned. To take advantage to the current tax codes, an individual should try to move earned income to unearned income to pay lower Federal income taxes.
References
Editorial. "It's time for the truth about taxing the rich." Maclean's. 124 (Oct 2011): 4-5. Business Source Premier.
Hoffman, et al. South-Western Federal Taxation: Comprehensive Volume, 12th ed. Mason: Cengage P, 2011. Print.
Earned income is taxed at a progressive rate: the higher the income, the higher the tax rate. These rates are 10%, 15%, 25%, 28%, 33% and 35% for the calendar year 2011. This income is also subject to payroll taxes. For the year 2011, one of the payroll taxes is on the first $106,800 and this is social security tax. This is called Old-Age, Survivors, and Disability Insurance (OASDI) tax and is taxed at a rate of 6.2%. Another payroll tax is Medicare Health Insurance (HI) and is on the entire earned income, but at a rate of 1.45%. Additionally these two taxes are matched by the employer. Individuals who are self-employed must pay both portions of the payroll tax at the same rates. However during 2011 and extended to 2012, there was a payroll tax break on the employee part of the social security tax and was reduced to 4.2%.
The capital gains, dividend and interest income, being classified as unearned income, are taxed at a lower rate than earned income because they are not subjected to the payroll tax. In addition capital gains have preferential tax treatment and are taxed at alternative rates. For example, the capital gain is taxed at 0% for the 10% and 15% Federal tax rate brackets and 15% for the Federal tax rate brackets above 15%. This tax rate is changing after 2012, when the 15% will be rising to 20%. The capital gains are taxed at a preferential rate in theory to increase investor activity and capital investments. Furthermore with respect to interest and dividends, some interest income is not subjected to tax at all, and some types of dividend income have preferential tax treatment. For example, interest income from state and local bonds is not taxed, and qualified dividends have the same preferential tax treatment as capital gains.
Individuals with higher total income pay a lower tax percentage because of this preferential tax treatment structure on capital gains, dividends and interest income. The lower tax percentage is also due to the social security payroll tax being limited to the first $106,800 of earned income. The higher income individuals often have a salary along with stock options and dividends. Due to preferential tax rates on the latter as unearned income, they tend to have a lower percentage of taxes paid to the Federal government. This being the case, some individuals often prefer to receive their income as unearned. For example, a billionaire that makes over $40 million a year pays a little less than $7 million in taxes; this is a tax rate at a little over 17%. Most of this income is taxed at a rate of 15% because the majority of income is capital gains. Other the other hand an individual making a salary of $50,000 a year generally cannot afford, nor is often offered, to take stock options instead of wages. With the lower income salary, the salary that individual earns, he or she will usually need it to sustain daily living expenses.
Due to the different types of income and the rates at which they are taxed, there is a preferential tax treatment to those that have more income, especially when that income is both earned and unearned. The individuals that earn a smaller earned income are additionally subjected to payroll taxes and thus results in usually higher total tax percentage. Individuals that have a combined income of both earned and unearned income pay a lower percentage than those who would take the same amount only as earned. To take advantage to the current tax codes, an individual should try to move earned income to unearned income to pay lower Federal income taxes.
References
Editorial. "It's time for the truth about taxing the rich." Maclean's. 124 (Oct 2011): 4-5. Business Source Premier.
Hoffman, et al. South-Western Federal Taxation: Comprehensive Volume, 12th ed. Mason: Cengage P, 2011. Print.
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