While the Democrats and Republicans debate what to do about tax rates for high earners, I've noticed there seems to be confusion or misinformation about whose taxes would actually go up. Many small business owners worry that they would be crippled by higher rates. There are two clarifications I want to make that may (or may not) make some salon owners sleep a little better at night.
1) When they talk about raising taxes for those making over $250,000 (or whatever threshold they are using on that particular day) they are talking about taxable income NOT revenue. My salon, for example, has over $900,000 in revenue annually, but our profit is less than $250,000. We will not be impacted by the rate increase. If your profits are over $250,000, first of all, well-done! Then, before you panic, see item 2 below.
2) The US has a marginal tax rate system. Which means when you jump to a higher bracket you don't pay that higher rate on ALL your taxable income, just the portion above the threshold. So let's say my salon has profits of $270,000 that are passing through to me for tax purposes. And for purposes of this post, let's say the rate that kicks in at $250,000 is 39.6% tax (versus the 35% that is currently the top rate). That 39.6% tax only applies to the portion of my taxable income ABOVE the $250,000 ($20,000 in our example). So when the top rate was 35% I would pay $7,000 on that $20,000 of my income, under the new plan I would pay $7,920.
Some people mistakenly think that the new top rate of 39.6% would apply to the entire $270,000 of taxable income. This is absolutely, 100% incorrect. That's not how our taxes work.
I hope this will make a few of you rest a little easier knowing that no matter who wins the election they will not come after all your hard-earned money! I wish politicians on both side of the aisle would do a better job explaining things instead of tossing about terms like "income" and "marginal rate" without explaining it in plain English.
So what do you think? If someone has taxable income of $1,000,000 should they be expected to pony up an additional $34,500 in taxes out of that last $750,000 of earnings?