Blog Ipsa Loquitur

I have to confess to being completely ignorant of how income taxes work as recently as last month. I’m still pretty ignorant, but I’m law school ignorant, which is a fair sight more educated than the guy who tries to sell you on Gold as the ultimate investment. Or folks who think that a 240% interest rate signals “safe bet.”

sidebar: The people who lost their savings were, by and large, operating through brokers. If ever there were a time when judges should consider sentencing someone to serve as the aggrieved party’s butler, (like that show within a show on Seinfeld) I think this is it. It’s not nice to throw away other peoples’ money.

The first and most fundamental concept of income tax is deciding what a taxpayer’s Gross Income is. Your Gross Income is your “raw” income, before you start doing any crazy deductions or hiding money in bizarre off-shore pyramid-shaped tax shelters. Tax liability is set at a certain percentage of a person’s gross income, so you have to know what that number is before you can decide what percent of it’s owed to Uncle Sam.  

Marginal Rates, An Intro To

Note that there’s no single percentage for your entire income. I don’t have the precise numbers in front of me, but as an example,

  • -Your first $30,000 is taxed at 10%,
  • The next $30,000_ [income between $30,001 and $60,000] is taxed at 15%,
  • The next $40,000 is taxed at 20%,
  • And then your next $100,000 [your income between $100,001 and $200,000] is taxed at 22%.
  • and so on and so forth.

There’s a popular misconception that if you made $120,000, your entire income would be subject to the 22% tax rate. Really, only $20,000 would be subject to that 22% tax rate in this fictional tax schedule. The real tax schedule works just like this, but with different numbers.

Back to Gross Income

The Internal Revenue Code lists a whole bunch of examples of what the IRS will consider gross income: the list isn’t exhaustive, but it does illustrate just how much stuff is gross income that you wouldn’t think should count.

In a rather recursive example, if your employer notices that you owe $15,000 in income tax this year, and promptly gives you the $15,000 to pay the IRS, that $15,000 is actually gross income. As a result, while you just handed the IRS a check for $15,000, now you’re counted as having made $15,000 more than you thought you did: you didn’t owe $15,000 in taxes, but $18,000.  You owe the IRS $3,000 more.

So now if your employer pays this extra $3,000, you’ll owe an extra $600, and so on and so forth. This recursion can only go on for so long: eventually, your employer will be tossing you fractions of pennies, and the IRS will be taxing a fraction of those fractions of pennies. You can whip up an Excel spreadsheet to do this math for you in a few minutes, if you like. Or you can read what Zeno had to say about these sorts of fractions of fractions of fractions.

So why on earth does the IRS get to keep taking more and more? If my employer will pay for my taxes, why should that count? I don’t get to keep the money. If I’m smart, I don’t ever even touch the money - it just goes right to the IRS. Surely you can’t tax me for money I never received, right?

Bringing it Home

Think about it this way: say you backed into Tony Soprano’s favorite Mercedes trying to park your car. He seems like a nice enough guy: he’s only going to take 10% of what you earn every week until you fix his car. The next day, you go into work and tell your boss that from now on, you want your company to pay for your rent, so Tony is none the wiser, and you get to keep more of your money.

Well, Tony might not immediately catch on that you’re lying about how much you make. But when he does, rest assured that Paulie Walnuts and Joey Baggadonuts are going to kick you and your boss in your respective shins very hard. You can’t trick either Tony or the IRS just by claiming you never touched the money: if you get someone to take care of money you owe (payment to Tony, or taxes to the IRS), that’s gross income.

Just be glad that when the IRS says they’re going to audit you, they don’t mean “beat you into unconsciousness with a baseball bat and stuff you in the trunk.”