What is a Tax Bracket?

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Definition:

A tax bracket is a range of income that the government taxes at a specific rate.

🤔 Understanding tax brackets

In the United States, there are seven federal income tax brackets. Because of the country's progressive income tax system, as you earn more money, you move into a higher tax bracket. Typically, you don’t pay all of your taxes based on the bracket that includes your annual income. Instead, due to marginal tax rates, you pay a different rate for each part of your income. So, many Americans pay a range of tax rates. Tax rates range from 10% to 37%, and the income thresholds for each bracket vary based on your filing status (single, married filing jointly, married filing separately, or head of household).

Example

Let’s say Jamie starts a new job and is trying to figure out how much she will pay in income tax for the year. Based on the $50,000 she expects to earn in 2021, she estimates that her income will fall into three different tax brackets: 10%, 12%, and 22%. Since Jamie has an understanding of how tax brackets work, she can make a rough estimate of what her income taxes will be for the year. She knows that with the standard deduction ($12,550 for a single filer in 2021), her taxable income will actually drop to $37,450, meaning she’ll pay federal taxes in two different income brackets: 10% and 12%.

Takeaway

Tax brackets are like a chore chart…

In a family, kids often do different chores based on their age bracket (e.g., taking out the trash). Every kid has to do the chores in the bottom bracket. As the kids get older and move into a higher age bracket, they take on extra tasks, maybe mowing the lawn or putting away the dishes. By the time they’re almost adults, they have to do every chore.

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How do tax brackets work?

The income tax system in the United States is progressive. As income increases, so does the amount of income tax you’re supposed to pay, so you move into a tax bracket with a higher rate. But due to marginal tax rates, you don’t pay the same rate on all of your income (unless all of your income falls within the lowest income tax bracket). Instead, you pay taxes on each dollar you earn at the rate of the tax bracket in which it falls.

Here are the federal tax brackets in the US for 2020 (the taxes that are due spring 2021):

Tax RateSingleMarried, filing jointlyHead of Household
10%$0 to $9,875$0 to $19,750$0 to $14,100
12%$9,876 to $40,125$19,751 to $80,250$14,101 to $53,700
22%$40,126 to $85,525$80,251 to $171,050$53,701 to $85,500
24%$85,526 to $163,300$171,051 to $326,600$85,501 to $163,300
32%$163,301 to $207,350$326,601 to $414,700$163,301 to $207,350
35%$207,351 to $518,400$414,701 to $622,050$207,351 to $518,400
37%$518,401 or more$622,051 or more$518,401 or more

Here are the federal tax brackets in the US for 2021 (the taxes that are due spring 2022):

Tax RateSingleMarried, filing jointlyHead of Household
10%$0 to $9,950$0 to $19,900$0 to $14,100
12%$9,951 to $40,525$19,901 to $81,050$14,101 to $54,200
22%$40,526 to $86,375$81,051 to $172,750$54,201 to $86,350
24%$86,376 to $164,925$172,751 to $329,850$86,351 to $163,300
32%$164,926 to $209,425$329,851 to $418,850$163,301 to $209,400
35%$209,426 to $523,600$418,851 to $628,300$209,401 to $523,600
37%$523,601 or more$628,301 or more$523,601 or more

How do you get into a lower tax bracket?

The lower your taxable income, the less you have to pay in income taxes. Our tax system in the United States provides opportunities to move into a lower tax bracket and pay less in income taxes, without reducing your gross income. You can do this through tax deductions, which you subtract from your taxable income when you file your taxes..

There are two options for income tax deductions: the standard deduction and itemized deductions. The standard deduction is a fixed amount that anyone can deduct. For single people, the standard deduction is $12,400 for your 2020 taxes and $12,550 for your 2021 taxes. The standard deduction for married couples is $24,800 for your 2020 taxes and $25,100 for your 2021 taxes.

The other option is to itemize deductions. There are hundreds of deductions available, and you can use any that apply to you. The more you deduct, the less you’ll pay in income taxes. Some popular deductions allow you to lower your taxable income based on interest payments you make on student loans, contributions you make to charities, and the money you contribute to your Individual Retirement Account (IRA) or 401(k) plan.

For most people, the amount they would be able to itemize ends up being less than the standard deduction. For them, it makes sense just to use the standard deduction. But if you qualify for enough itemized deductions that they add up to more than the standard deduction, you can go that route instead. Just keep in mind, you can only do one or the other.

What is an effective tax rate?

We know that tax brackets represent the marginal tax rate that applies to each chunk of your income, and that your income will typically fall into multiple different brackets. Your effective tax rate is the average tax percentage that you pay on all of your income.

For example, let’s say you made $50,000 in 2020 and filed as a single individual. Your income falls into three different federal tax brackets: 10%, 12%, and 22%. After you apply the standard deduction of $12,400, your taxable income is $37,600. Now your income only falls into two tax brackets: 10% and 12%.

The first $9,875 of your income falls into the first tax bracket, which has a tax rate of 10%. You pay a total of $987.50 in income taxes for this portion of your income. The next $27,725 falls into the second tax bracket with a tax rate of 12%. You pay a total of $3,327 in income tax for this portion of your income.

In this example, your total federal income tax burden for 2020 is $4,314.50. To find your effective tax rate, divide the total amount you paid in income taxes by your total income of $50,000, which is 8.6%. Thanks to the standard deduction and the progressive tax system, your effective tax rate is lower than the lowest federal tax bracket.

Are state and local tax brackets the same as the federal tax brackets?

Depending on where you live, you may owe state or local taxes too. As of 2021, eight states — Alaska, Florida, Nevada, South Dakota, Texas, Tennessee, Washington, and Wyoming — do not have a personal income tax. If you live in a different state, you’ll pay state income tax. As of 2021, state income tax rates range from a low of 2.9% in North Dakota to a high of 13.3% in California.

You may also have to pay local taxes in 16 states that allow cities and counties to levy their own income taxes. Depending on where you live, you could potentially end up paying three different income tax bills — federal, state, and local. States that allow local income taxes include Alabama, Arkansas, California, Colorado, Delaware, Indiana, Iowa, Kentucky, Maryland, Michigan, Missouri, New Jersey, New York, Ohio, Oregon, and Pennsylvania.

What are some common myths about tax brackets?

The income tax system in the United States can be a bit confusing, which leads to a lot of misinformation. One of the most common misconceptions about income tax brackets is that increasing your income could lower your net income (meaning the amount you get to take home after taxes).

Where does this confusion come from? Many people think that they pay one tax rate on their entire income, so they fear that increasing their income and moving into a higher tax bracket would actually reduce the amount of money they take home in the end. But usually, this is not the case. If an increase in your income pushes you into the next tax bracket, only the portion of income that falls into that tax bracket will have a higher rate. The rest of your income will continue to fall into the same tax brackets as before.

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