Von Balanon | Mustang News

You hear all the time from students they’d wish school would teach them important things like how taxes work. Well, here’s exactly that on a basic level:

Let’s say you’re about to graduate from Cal Poly and have found a job that pays $50,000 (the average starting salary for college grads). Let’s take a look at how much you’ll pay in taxes.

The first thing you should know is that you’re not taxed on your full $50,000, otherwise known as your gross salary. Taxes are only applied to your taxable income, which is your gross salary minus a few types of tax deductions. 

One deduction is called the federal standard deduction whereby single people (ie: not married) get to deduct $12,550 from their gross income. Additionally, the money you set aside in investment accounts (ie: 401k or IRA) also counts towards reducing your taxable income. Let’s say you want to invest 10% of your gross salary ($5,000) in a 401k your first year. That means your taxable income comes out to be $32,450.

Summary of Gross to Taxable Income
Gross Salary $50,000
Standard Deduction $12,550
Money for an Investment Account $5,000
Taxable income $32,450

(Note: you’re not actually paying that $12,550 in taxes, you get to keep that money. You’re just not paying taxes on that money.)

So how are taxes applied to that $32,450? In the United States, income is taxed through what’s called a progressive tax. You pay different tax rates based on certain tax brackets. Let’s take a look at the 2021 federal income tax brackets to see how this works.

Federal Income Tax Brackets (Tax Year 2021 / Filed April 2022)
Tax Bracket Tax Rate Your Income in this Bracket What You Owe
$0.00 – $9,950.00 10% $9,950 $995
$9,950.00 – $40,525.00 12% $22,500 $2,700
$40,525.00 – $86,375.00 22%    
$86,375.00 – $164,925.00 24%    
$164,925.00 – $209,425.00 32%    
$209,425.00 – $523,600.00 35%    
$523,600.00 + 37%    
Total Federal Taxes $3,696

(Note: As a quick sanity check, the Your Income in this Bracket amount should add up to $32,450 (ie: your taxable income.))

So your taxable income fits into two different tax brackets. On the first $9,950 you pay 10%, which results in $995 for that bracket. Then on the money you earned between $9,950.00 and $40,525.00, which in this case is $22,500 ($32,450 – $9,950), you pay 12%, which results in $2,700 for that bracket. In total, you’ll pay $3,695 for federal income taxes. That’s not the end because there’s also state taxes. The following is assuming you work in California, other state income tax rates can easily be found at www.tax-brackets.org

(Note: As a quick sanity check, the Your Income in this Bracket amount should add up to $32,450 (ie: your taxable income.))

In California state taxes, you’ll pay $792.25. Unfortunately, there’s still more taxes to be paid in the form of Social Security, Medicare, and CASDI (California State Disability Insurance). If you’ve ever held a part-time job before, you might have noticed on your paychecks that these are automatically taken from you. They’re calculated based on a percentage of your gross salary of $50,000, not your taxable income. Below is a summary of what you’ll pay for those three.

Other Taxes
Paycheck Tax Tax Rate What You Owe
Social Security 6.20% $3,100
Medicare 1.45% $725
CASDI 0.90% $450
Total Other Taxes $4,275

(Note: These percentages are applied to your gross salary of $50,000, not your taxable income.)

Finally, let’s display a summary of all the taxes you’ll pay, including investments, to see what you have left, otherwise known as your net income.

Summary of Gross Salary to Net Income
Gross Salary $50,000
Federal Taxes $3,696
California State Taxes $792.25
Other Taxes $4,275
Total Taxes $8,763.25
Money for an Investment Account $5,000
Net Income $36,236.75

Based on a salary of $50,000 living in the state of California, you’ll pay $8,763.25 in taxes. Assuming you invest $5,000 of your annual salary for a retirement fund, that leaves you with $36,236.75!

Now you may be tempted to say, “well, if I don’t invest that $5,000 every year, that’s more money in my pocket.” While true, it’s usually advised that you put some money away for retirement. The reason why is due to the time-value of money and the amazing effect of compound interest! Let’s look at a quick example to demonstrate this.

Your current retirement plan is to invest $5,000 every year for 40 years. Let’s say that your money earns on average 7% per year. Based on that estimate, you’ll have earned almost $1.1 million over 40 years! If instead you wanted to just keep that $5,000 every year for 40 years, you’d only come away with $200,000 (40 * $5,000).

If investing in your future interests you and you’re asking yourself: but what do I invest in? I’d recommend checking out an article I wrote called Investing For Dummies — Also Known As College Students, where I explain investing is not that complicated. When you invest in something called an index fund for the long-run, it’s actually relatively safe and extremely lucrative (ie: low risk, high reward). I’d also recommend reading the book The Millionaire Next Door by Thomas J. Stanley and William D. Danko. They explain how (almost) anyone in the United States can become a millionaire (Spoiler alert: it’s done via diligent saving and investing, not necessarily a high income — which is why a large proportion of American millionaires are teachers).

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