How Do Tax Brackets Work?
Have you ever heard someone claim something like “I’m in the 22% tax bracket!”? Claims such as these are often misguided. There is a misconception that all of your income is taxed at a certain percentage rate – this is not how income tax brackets work.
New federal income tax brackets are issued each year by the IRS. These tax brackets might look similar year to year, but adjustments are made annually to allow for inflation. The IRS has already released the 2020 income tax brackets, so how do you calculate your federal income tax using these tax brackets?
Let’s look at an example to see how this calculation is done. For our example, let’s say you are married, filing jointly, and that your joint income in 2019 was $95,000.
First, look at the portion of the proper income tax bracket (in our example this would be the 2019 income tax bracket for married, filing jointly).
|Married, Filing Jointly|
|Rate||Taxable Income Bracket|
|10%||$0 to $19,400|
|12%||$19,401 to $78,950|
|22%||$78,951 to $168,400|
|24%||$168,401 to $321,450|
In our example, the $95,000 of income earned will not all be taxed at the same rate. The first $19,400 of income will be taxed at 10%, the next $59,550 ($78,950 minus the first $19,400) will be taxed at 12%, and finally the last $16,050 ($95,000 minus $78,950) will be taxed at 22%.
Even though in our example, an income of $95,000 falls within the “22%” income tax bracket, the total tax is not actually 22% of the total income. The total tax due, $12,617, is only 13.3% of the total income!
Understanding how income tax brackets work can be beneficial for tax planning purposes. Tax deductions, for example, lower the amount of your income that is considered taxable. Having less income that is taxable could put you in a lower tax bracket and, thus, result in less taxes due.
Contact CPA Nerds
If you would like to learn more about tax brackets and your unique tax situation, please talk to us. Our accountants can help you plan ahead to make the most of the next tax year. Contact us online or call us at (586) 468-0200 to get started.