Income Taxes – Bush vs. Obama vs. Trump Part 2: Federal Individual Income Tax Overview, How it Works

The federal income tax structure is a progressive tax structure. Theoretically, the more you make the more you pay. This structure has been a principle tenet of the federal income tax system, and remained in place under Presidents Bush, Obama, and Trump. As demonstrated below, there are progressively higher tax rates that apply to increasingly higher income levels. The typical American family pays about one-third of its gross (total) income in taxes.

Each pay period you will have income taxes withheld from your paycheck. Generally, each year you must file a tax return by April 15 which reflects your income tax liability for the previous year. Your tax return will determine your tax liability for a given year, given your filing status, income, deductions, and credits. Your tax liability is compared to your total income taxes withheld during the year. If your liability is more than what was withheld, you must pay. If your liability is less than what was withheld, you will get a refund.

To provide a simplified example of how income taxes are calculated, we will use the tax rates in effect in 2017. Later, we will explain what changed in 2018. Your taxable income is your gross income (generally wages and investment income) minus certain deductions and credits. The 2018 tax law also changed the amount of taxes withheld. So, your tax refund or the amount you had to pay in taxes may have been different than what you expected.

Let’s assume you were single in 2017 and had wages of $48,350. The “standard deduction” in 2017 was generally $6,350 (slightly higher if blind and/or over 65) for a single taxpayer ($12,700 for married filing jointly), meaning a single taxpayer got at least a $6,350 deduction. Why $6,350? Because that was the law. It was possible to get more than $6,350, if you could “itemize” deductions. Possible itemized deductions included mortgage interest, state and local taxes, certain medical expenses, and charitable contributions. If your itemized deductions exceeded the standard deduction amount, then you took the itemized deduction amount. If itemized deductions were less than the standard deduction amount, then you took the standard deduction. In addition to this deduction, taxpayers could get an additional deduction for “exemptions”. The exemption amount you could take as a deduction was generally $4,050 x number of dependents (generally 1 for yourself, 1 for your spouse if filing jointly), plus the number of children if you provided the majority of their financial support and they were younger than 19 or a full-time student younger than 24. The exemption amount was phased out for high income taxpayers.

So, in our simplified example for a single taxpayer, the taxable income is calculated below, assuming the standard deduction is taken and there is one exemption:

Income: $48,350
Less: Standard deduction: $6,350
Less: Exemption: $4,050
Taxable Income: $37,950

Tax tables, which are set by law, are used to determine the taxpayer’s tax liability.

2017 tax tables, which show the tax rate applicable for income in a given bracket by filing status, are indicated below. The brackets are generally adjusted each year for inflation.

Tax Rate	Single	Married Filing Jointly	Married Filing Separately	Head of Household
10%	$0-$9,325	$0-$18,650	$0-$9,325	$0-$13,350
15%	$9,326-$37,950	$18,651-$75,900	$9,326-$37,950	$13,351-$50,800
25%	$37,951-$91,900	$75,901-$153,100	$37,951-$76,550	$50,801-$131,200
28%	$91,901-$191,650	$153,101-$233,350	$76,551-$116,675	$131,201-$212,500
33%	$190,651-$416,700	$233,351-$416,700	$116,676-$208,350	$212,501-$416,700
35%	$416,701-$418,400	$416,701-$470,700	$208,351-$235,350	$416,701-$444,550
39.6%	$418,401 and above	$470,701 and above	$235,351 and above	$444,551 and above

The rates apply to the income in a given bracket. For example, if you are single, you paid a 10% rate on income up to $9,325. In 2017, income over $9,325 was taxed at a 15% rate up to $37,950. So if your taxable income was $37,950, your tax liability was .10($9,325) + .15($37,950-$9,325) = $5,226.25. The “marginal tax rate” would be 15%. The marginal tax rate refers to the rate that applies to the tax bracket the taxpayer falls based on total taxable income. The $5,226.25 is your tax liability – you got a tax refund if more was withheld from your paychecks, you paid taxes if less was withheld from your paychecks.

Note – an important point is that everyone pays the same rate for taxable income in a given bracket. You, me, and President Trump pay a 10% rate for income in the lowest tax bracket. You, me, and President Trump pay a 15% rate for income in the next highest bracket. So single taxpayers, no matter what their total taxable income was, paid a 10% rate on the first $9,350 of taxable income in 2017. We kept the example simple to try and explain the fundamentals. There were certain tax credits available that reduced taxable income, and taxes on investment income was subject to different tax rules, as explained later. An additional deduction was also available for a contribution to a traditional individual retirement account.

CBEI Blog Series: Income Taxes – Bush vs. Obama vs. Trump
Part 1: Intro
Part 2: Federal Individual Income Tax Overview, How it Works
Part 3: President Obama vs. President Bush
Part 4: President Trump vs. President Obama
Part 5: Corporate Incomes – Briefly but Importantly