The exceptions » Not all income is taxed at the rates outlined above. A key exception is any money earned from long-term investments, such as stocks, mutual funds and real estate held for at least a year. This income is classified as capital gains and is taxed at a flat 15 percent. That’s regardless of whether it’s $100 or $1 million.
An example of how taxes are calculated
A person’s taxes are not calculated solely on his or her salary. Lots of things come into play. But here’s a simplified version of how someone’s taxes might be calculated:
A single man in his early 30s working as a midlevel executive makes $98,650.
Gross income $98,650
Personal exemption for 2011 $3,700
Standard deduction for 2011 $5,800
Taxable income $89,150
Tax on the first $8,500 (at 10%) $ 850
Tax on the next $25,999 (at 15%) $3,900
Tax on the next $49,099 (at 25%) $12,275
Tax on the next $5,549 (at 28%) $1,554
Total federal tax bill $18,579
Tax rate, compared with his gross income 18.8%
Sources: The Associated Press, The IRS
"This is why someone who’s a millionaire might have an effective tax rate that’s lower," said Gil Charney, a tax analyst with H&R Block’s Tax Institute. "A higher percentage of their income is going to be from long-term investment income."
In Romney’s case, a chunk of his income in 2010 and 2011 came from Bain Capital, the private equity firm he founded and managed between 1984 and 1999.
Bain still pays Romney "carried interest," which is a classification of pay for managers of hedge fund and private equity firms. Critics say this type of compensation should be taxed as salary at ordinary rates. But as it stands, carried interest is considered capital gains because it’s profit in excess of what investors paid into the fund, Charney said.
The tax rate for capital gains wasn’t always 15 percent. The rate has moved up and down through the years. In the 1970s, for example, the figure was close to 40 percent. And if Congress doesn’t act by the end of the year, the capital gains tax rate will revert back to 20 percent.
Reducing taxes » Tax rates are subject to political influences. But there are a few standby strategies taxpayers can use for reducing their tax bill.
A key tactic is to reduce taxable income; this is why financial planners are such advocates of maximizing contributions to 401(k) accounts. Workers can reduce their taxable income by as much as $17,000 a year. For traditional individual retirement accounts, the maximum contribution is $5,000 a year.
Most large employers also let workers set aside up to $5,000 of pre-tax wages in a health care flexible spending account. This money can be used for a variety of medical costs, including co-pays, prescription drugs and supplies such as cold packs.
There are also tax breaks for donations and education and health care costs that you may incur anyway.