Not everyone pays the same amount in taxes. In fact, your tax brackets can differ greatly based on how much you earn.
The US tax system is a type of progressive tax system. That means you must pay more in tax if you earn more. Your average millionaire will pay a higher percentage of their income to the government than someone who’s currently eligible for government assistance.
What Does the IRS Mean by “Tax Bracket”?
One of the ways the tax system works is that the IRS has several designated tax brackets, based on how much you earn. These tax brackets are simply designated income limits that correspond to different tax rates.
The 2020 tax year is an important one because five of the existing seven tax brackets have changed, due to the overhaul of the tax code.
There are still seven tax brackets. The lowest tax bracket still has just a 10% tax rate. The highest marginal tax rate for high income earners is 37%. However, the other five tax brackets have seen decreases of between one and four percent.
Your taxable income will determine which of the brackets you fall into and, ultimately, how much tax you pay.
How Can I Find Out Which Tax Bracket Applies to Me?
To help you understand how it works, we are going to use a real-life example.
Let’s take a single taxpayer who earns $60,000 per year. They take all exemptions and deductions they can. To begin with, the first $9,525 they earn is eligible for the 10% tax rate. Up to $38,700 they will pay 12% on that income. The rest of the taxpayer’s income will be taxed at 22%.
This is the tax bracket that taxpayer falls into, but due to the fact they’re moving through the lower tax brackets their effective tax rate is far lower.
A married couple filing jointly will be taxed 10% on the first $19,050 earned. However, anything up to $77,400 will be taxed at just 12%.
Take note that the money earned from a job is gross income or ordinary income. However, the IRS taxes you on your adjusted gross income.
To get your adjusted gross income you must take your gross income and deduct any adjustments, deductions, and exemptions.
After calculating your tax bracket, you can calculate the value of the different tax deductions available to you. For example, someone in the 22% tax bracket would see a $1,000 deduction translate to a reduced tax liability of $220.
Remember that not all your income is taxed as part of the same bracket. You also have long-term capital gains, which could be taxed as high as 20% or as low as 0%. Short-term capital gains, on the other hand, are taxed as ordinary income.
How Have the Tax Brackets Changed?
The seven tax brackets remain the same, but five of them have been lowered. The old brackets were as follows:
But the new brackets have changed. They’re now lower. These new ones are as follows:
You should also know that the income thresholds have been changed. So be aware of those before you assume anything. Make sure you talk to a tax professional first.
Try the Online Tax Bracket Calculator
Being able to decipher which tax bracket you fall into is vital to making the right financial decisions. But if you use an online tax bracket calculator, you don’t need to carry out any complex calculations.
All you must do is plug your numbers into the calculator and it will work it out for you, including adding in any adjustments and deductions.
You can also use an online tax filing platform to get help from a tax professional by using live chat. This can be useful for ensuring your tax questions are answered and that your return is fully checked.