8

I am trying to determine how much money I will save by participating in the TransitChek program. The way the program works is I can set aside a certain amount of money from my pay check before taxes are taken out for public transportation (you never have to pay taxes on these costs).

So lets say I spend $1,000.00/year on transportation and I get 60% of my gross pay taken out in taxes. Does that mean that I am saving $600 in a year? ($1,000.00 * 0.60) This amount seems like too much.

4

I have a very hard time believing you pay 60% of gross.

Otherwise, I believe you're right in the way this works:

Suppose you make $100k and pay 25% of that in taxes.

100,000 * .25 = 25,000

But if you spend $1,000 pretax, then it's as if you were paid $99,000

99,000 * .25 = $24,750

So the difference is $250. Which is the same as that $1,000 * .25.

  • 1
    Thanks, the numbers were just made up for ease of calculation. – Tim Feb 18 '10 at 15:30
5

Actually, the other answer isn't strictly correct. It's an estimate, giving a lower bound that gets less accurate as income increases. Consider: U.S. income tax is based on a progressive tax system where there are income bracket levels with increasing tax rates.

Example: Given U.S. 2009 federal tax rates for an individual filing as "single":

Income level          Tax Rate
$0 – $8350  ........:  10 %
$8351– $33950 ......:  15 %
$33951 – $82250 ....:  25 %
$82251 – $171550 ...:  28 %
$171551 – $372950 ..:  33 %
$372951+ ...........:  35 %

Imagine somebody making $100000. Assuming no other credits, deductions, or taxes, then income tax based on the above brackets & rates would be calculated as follows:

8350*0.10+(33950-8350)*0.15+(82250-33950)*0.25+(100000-82250)*0.28 = 21720

Meaning the average tax rate for the single individual earning $100,000 is 21.72%.

However, a pre-tax deduction from that income actually comes off at the top marginal tax rate. Consider the same calculation but with taxable income reduced to $99,000 instead (i.e. simulating a pre-tax $1000 deduction):

8350*0.10+(33950-8350)*0.15+(82250-33950)*0.25+(99000-82250)*0.28 = 21440

That's a difference of $280, which is more than the $217.20 savings that would have been estimated if just using the average tax rate method.

Consequently, when trying to determine how much money would be saved by a tax deduction, it makes better sense to estimate using the marginal tax rate, which in this case was 28%. It gets a little trickier if the deduction crosses a bracket boundary. (Left as an exercise to the reader :-)

Finally, in the case of the deduction being discussed, it also looks like payroll FICA taxes paid by the employee (Social Security's 6.2%, and Medicare's 1.45%) would be avoided as well; so add that to the marginal tax rate savings.

The surest way to know how much would be saved, though, would be to do one's income tax return calculation without the deduction, and then with, and compare the numbers. Tax software can make this very easy to do.

  • I always prefer the complex (but accurate) explanation to the over-simplified. People in this country enjoy simplified explanations so much, but we live in a complex world. They are kidding themselves. – Mark E. Haase Sep 10 '11 at 17:37

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