SOME TAX BASICS
A general understanding of how our tax system works is critical for informed voters to reach their own considered opinion about US budget priorities, deficits and tax rates. Very simplistically, the IRS collects taxes on individuals and households as follows:
Ordinary income + Capital Gains + Dividends=Gross income
Gross income – Capital losses - allowable deductions= Adjusted gross income
The adjusted gross income is then taxed in a ‘progressive’ manner, meaning that the higher the
amount, the higher the tax rate(commonly referred to as the ‘marginal tax bracket’).
As the terms, definitions and explanations below explain, different types of income are taxed at different rates. While the specific treatment of various forms of income and deductions can be quite complex, the big picture is essentially as above.
Ordinary income: “Income received that is taxed at the highest rates, or ordinary income rates.
Orindary income is composed mainly of wages, salaries, commissions and interest income (as from bonds). Ordinary income can only be offset with standard tax deductions..”
Adjusted gross income (“AGI”): “A United States tax term for an amount used in calculation of an individual’s income tax liability. AGI is calculated by taking an individual’s gross income and subtracting the Income tax code’s enumerated deductions..”
Capital Gains and Losses
Almost everything owned and used for personal or investment purposes is a capital asset. Examples are a home, household furnishings, and stocks or bonds held in a personal account. When a capital asset is sold, the difference between the basis in the asset and the amount it is sold for is a capital gain or a capital loss. If you received the asset as a gift or inheritance, refer to Topic 703 for information about your basis. You have a capital gain if you sell the asset for more than your basis. You have a capital loss if you sell the asset for less than your basis. Losses from the sale of personal-use property, such as your home or car, are not deductible.
Capital gains and losses are classified as long-term or short-term. If you hold the asset for more than one year before you dispose of it, your capital gain or loss is long-term. If you hold it one year or less, your capital gain or loss is short-term.
Capital gains and deductible capital losses are reported on Form 1040, Schedule D (PDF). If you have a net capital gain, that gain may be taxed at a lower tax rate than the ordinary income tax rates. The term "net capital gain" means the amount by which your net long-term capital gain for the year is more than the sum of your net short-term capital loss and any long-term capital loss carried over from the previous year. Currently net capital gain is generally taxed at rates no higher than 15%, although, for 2008 through 2010, some or all net capital gain may be taxed at 0%, if it would otherwise be taxed at lower rates. There are three exceptions:
1. The taxable part of a gain from selling Section 1202 qualified small business stock is taxed at a maximum 28% rate.
2. Net capital gain from selling collectibles (such as coins or art) is taxed at a maximum 28% rate.
The part of any net capital gain from selling Section 1250 real property that is required to be recaptured in excess of straight-line depreciation is taxed at a maximum 25% rate. http://www.irs.gov/taxtopics/tc409.html
Current (and future) Capital Gains Rates
The IRS classification of qualified dividends generally leads to a lower tax liability for most tax payers. Although there are a number of additional steps involved in calculating your total tax in light of the impact of qualified dividends, doing so reduces the amount you owe.
Definition of Dividends
Dividends are paid by corporations to its investors, and they may be paid as cash, stock or other property. Dividends represent a share of the profit earned by a corporation over a set time period. Dividends are considered income by the IRS and taxed accordingly. Ordinary dividends are the most common type of payout and are taxed as regular or "ordinary" income at your normal tax rate. Unless a corporation specifies otherwise, dividends are considered to be ordinary.
Some dividend payments fall into a "qualified" category and are subjected to a lower tax rate. According to the IRS, "Qualified dividends are the ordinary dividends that are subject to the same 0% or 15% maximum tax rate that applies to net capital gain." There are restrictions that must be met for dividends to be considered "qualified." First, the dividend must be paid by a U.S. corporation or qualified foreign corporation. Secondly, the dividends must not fall into the IRS's "not qualified" category, and lastly, they must meet the specified holding period.
Qualified dividends that normally fall into the 25-percent tax-rate bracket are taxed at 15 percent. If the regular applicable tax rate is less than 25 percent, qualified dividends are then taxed at 0 percent.
You must own the stock that earns the dividends for more than 60 days of a prescribed 121-day period. That period begins 60 days prior the "ex-dividend date." The IRS defines the ex-dividend date as "the first date following the declaration of a dividend on which the buyer of a stock will not receive the next dividend payment. Instead, the seller will get the dividend." The holding period effectively requires tax payers to commit to longer-term investments ensuring any dividends earned fall into the qualified category.
Marginal tax bracket: “The highest tax rate imposed on your income.”
Average tax rate: “This rate is a person’s total federal tax liability divided by his or her total
Obama's Proposals for Changing the Marginal Tax Brackets
Currently there are six tax brackets: 10%, 15%, 25%, 28%, 33%, and 35%. Those tax brackets were implemented in 2001 and are scheduled to expire at the end of 2010. If Congress does not pass a new law, the marginal tax brackets will revert to their pre-2001 levels, which were five tax rates of 15%, 28%, 31%, 36%, and 39.6%.
Instead of reverting to these tax rates, President Obama has proposed to continue using six tax rates: the 10% through 28% tax rates would remain the same and the top two rates would of 33% and 35% would be replaced with 36% and 39.6% rates, respectively. How income is measured in determining the tax bracket would also change. The 36% bracket would begin at $200,000 minus the standard deduction and one personal exemption for single filers, and at $250,000 minus the standard deduction and two personal exemptions for married filers. How tax rates are determined remains unchanged for the other tax brackets. The beginning of the 39.6% bracket was not explained in the administration's Greenbook. The new tax rates would begin in 2011, but requires Congressional action to implement these legislative proposals. http://taxes.about.com/od/preparingyourtaxes/a/tax-rates.htm
SOME 2008(most recently available) BASIC TAX FACTS
FOR THE TOP 3% OF TAX RETURNS (those with an AGI in excess of $204,000)
Number of returns: 4,198,817
Total Adjusted Gross Income(“AGI”): $2.43 Trillion
Total Income Tax Paid: $530.1 Billion
Average Tax Rate: 21.88%