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A Look at How Taxes Impact Those Earning the Median Income or Less

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A Look at How Taxes Impact Those Earning the Median Income or Less
With all the talk about who may or may not be paying their fair share of taxes, I thought I would break down how income taxes impact those in the middle of the financial spectrum. At the same time, you'll get a useful example of how taxes really work.

According to the Census Bureau, the median household income in the U.S. in 2010 was $49,445. In simple terms, "median" means that half of all households earned more than that and half earned less. The bureau also calculated the medians for families and single people. For families—defined as two or more related people living together—the median household income in 2010 was $61,544, while for single people it was $29,730. (Without trying to add to the confusion, I should point out that "median income" does not mean average income. If everyone's earnings were spread evenly throughout the U.S. population, the household income would be considerably higher than the median.)

What happens when these income examples are used on a tax return? Assuming that all the income was earned as an employee and reported on a W-2, here is how it breaks down:

Let's posit a household of two adults and two children, with the children young enough for the family to benefit from the Child Tax Credit (meaning under age 17, with additional qualifications). Using only the standard deduction for a married couple filing jointly ($11,400) and claiming four exemptions (two for the parents and two for the kids, at $3,650 apiece), a total of $26,000 in deductions can be taken on the median income of $61,544. Such a household would have a total federal income tax bill of just $1,691.

Most people think they are taxed on their gross (or overall) income. Not true. Although the family's gross income was $61,544, its taxable income (the amount you are really paying taxes on) was just $35,554. That's the gross income of $61,544 minus the $26,000 in deductions (the standard deduction and the four exemptions).

Using the rules for the current tax season (tax year 2010), the tax for this family would have been $4,491. But because the two children qualify for the Child Tax Credit ($1,000 each) and the government allows an additional Making Work Pay Credit of $800 total for the two adults, the tax owed by this family is just $1,691 ($4,491 minus $2,800).

$1,691 is only 2.75 percent of the family's gross income of $61,544. What's more, if the family's income had been the national household median of $49,445, it not only wouldn't have had to pay any taxes but would have received a refund of $124.

Compare that with a single individual earning the median income of $49,445. Because the standard deduction for a single person ($5,700) is half that for a married couple, and a single person is allowed just one exemption (worth $3,650), that person's total deductions come to $9,350. His or her taxable income would thus be $40,095. Allowing for a $400 Making Work Pay Credit, he or she would owe $5,800 in taxes (or 11.73 percent of gross income).

Even using the median income of $29,730 for a single person, he or she would still owe $2,238. That's more than 7.5 percent being paid in taxes on gross income.

How little does a single person have to make before he or she owes nothing in taxes? That would be $13,400, at which level he or she would receive a refund of $4, essentially the result of what's called the Earned Income Tax Credit.

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