Is there any topic more confusing than taxes? Probably not. With seven federal income tax brackets to understand, most Americans rely on a tax expert to handle the pesky yet essential obligation of calculating and paying taxes every April.
Even if you’re not ready to become a TurboTax guru, it helps to understand the basic ins-and-outs of the U.S tax brackets and what they mean for your paycheck and tax refund.
How Tax Brackets Work
Tax brackets create a system of marginal taxation, also known as progressive taxation. Its goal is to tax citizens based on their earnings so that low-income earners aren’t burdened by high rates they can’t afford.
The exact arrangement of tax brackets has always been a controversial topic; some people believe marginal taxation offers an equitable method to distribute taxes, while others believe it discourages Americans from working hard to become wealthy.
Overall, tax brackets assess a specific tax rate on a certain portion of your income. Since the United States uses a federal marginal tax rate that increases as income rises, the more you earn, the more you pay. You’re not charged a single, static tax percentage of your entire income.
For example, based on the current tax brackets, the first $9,700 you made in 2019 will be taxed at 10%, which equals $970. However, all of the money you make between $9,701 and $39,475 is charged at a slightly higher tax bracket rate of 12%. If you were lucky enough to earn more than $39,475, you hit the next tax bracket of 22%.
Let’s say you made $45,000 in 2019. Here’s what your tax bracket breakdown looks like:
- Income up to $9,700= 10% tax rate = $970 in taxes
- From $9,701 to $39,475= 12% tax rate = $4,543 in taxes
- From $39,475 to $45,000= 22% tax rate = $1,215.50 in taxes
That comes to a total of $6,728.50 in taxes on a $45,000 income in 2019. As you can see, higher taxes are assessed in steps or chunks as you reach higher earning thresholds.
Tax Brackets This Year (2020)
If you’re preparing your taxes for the 2019-2020 season, here’s a breakdown of how your income will be taxed by the IRS. Keep in mind that single filers use different income brackets than married couples filing jointly.
- 10% for income $0- $9,700 (or $0-19,400 for married couples filing jointly)
- 12% for income $9,701- $39,475 (or $19,401- $78,950 for married couples filing jointly)
- 22% for income $39,476- $84,200 (or $78,951- $168,400 for married couples filing jointly)
- 24% for income $84,201- $160,725 (or $168,401- $321,450 for married couples filing jointly)
- 32% for income $160,726- $204,100 (or $321,451- $408,200 for married couples filing jointly)
- 35% for income $204,101 to $510,300 (or $408,201- $612,350 for married couples filing jointly)
- 37% for income $510,301 or more (or $612,351 or more for married couples filing jointly)
These tax brackets change every year and are always available in advance, so you can already see what your tax brackets look like for 2021 as well.
Why Is All Of This Important?
Tax brackets demonstrate exactly why strategic savers use pre-tax investments like employer-matched 401(k) accounts and tax-deductible accounts like traditional IRAs to decrease their amount of taxable income.
If you normally make $250,000 a year, more than $40,000 of your income is hit with a 35% tax rate unless you can claim a lower taxable income after your investments. It’s easy to save tens of thousands of dollars this way.
See Also: Tax Exemptions Explained
