What is a tax bracket, and what does it mean for you?
The United States federal income tax utilizes a progressive – or tax bracket – system to determine how much singles or married couples will pay in yearly taxes. Since the implementation of the American Taxpayers Relief Act, the IRS divided the taxpayer population into seven tax brackets, determined by the amount of personal income earned within the space of a year. The more money you make, the higher you rise in the ranks of the seven tax brackets and the more you will pay to the IRS.
The rate of the first tax bracket is 10% for modest wage taxpayers, and the tax brackets increase up to the highest bracket of 39.6% for the highest income taxpayers.
The Ugly Truth About Tax Brackets Becomes More Complicated
However, you will not pay a flat rate for the entire amount you earn in a year. Using the marginal tax rate system, the higher a taxpayer’s income, the more they will pay to the IRS per dollar earned. Within each tax bracket, the tax follows progressively higher levels. That’s why you will pay more tax on the high end of a tax bracket than on the lowest end.
The Math of a Taxpayer
Consider the example of a single person with no dependents and a salary of $50,000 a year. Earning that amount of income will automatically slot that person into the 25% tax bracket. However, that rate will only apply to the last $12,550 of the entire taxable amount. The tax on the remaining $37,450 of this taxpayer’s salary is at a much lower rate of 15% for $28,225 and then 10% for the amount of $9,225. If this taxpayer earns one dollar over $50,000 in a year, the marginal tax rate will increase to 28%.
Married couples filing a joint tax return will pay less than the example taxpayer above. However, some couples prefer to file separately.
An Uglier Truth – The More You Make the Less You Keep
Thanks to the sneaky marginal tax rate, the more money the taxpayer earns, the more the rate will creep up and the less they will get to keep after paying taxes to the IRS. There is a silver lining to this situation, however.
The Good News
Approved tax deductions work to help taxpayers reduce the increased amount of income tax that accompanies an increase in salary. By subtracting qualified deductions from the amount of gross income, the amount of federal tax paid to the IRS will be lower.
The following tax strategies will decrease your tax payments:
- Yearly amounts paid in interest on mortgages
- Contributing to a retirement plan such as a 401K
- Donating to an IRS-approved charity
- Approved tax credits for energy consumption home improvements
- Children born that tax year
Are You Self-Employed?
The self-employed will need to utilize a different plan than other taxpayers, according to the IRS. This particular group of taxpayers will need to make quarterly payments based on a projection of their earnings. To make sure you pay the correct amount, self-employed taxpayers should hire a certified tax professional to calculate your quarterly tax payments. A qualified tax professional can also minimize the marginal tax rate and save you money on your tax liability.
A Tax Professional Can Help
A certified tax professional is an expert in the current tax laws. Using their extensive knowledge and experience, they will work with the taxpayer to evaluate each situation. Then they formulate a strategic plan to help lower tax payments. Hiring a professional to make sure you pay the correct amount of taxes is very important to avoid any penalties.