What Most People Don't Understand About Tax Brackets

What Most People Don't Understand About Tax Brackets

December 5, 2019
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Tax brackets seem simple enough – the more money you make, the more taxes you pay, there’s more to it than that, and it is important to understand why.

What are the Tax Brackets?

The tax brackets are simply broken down by income level. The exact bracket you’ll fall into depends on how you file your taxes. Are you single, married filing joint, married filing separate, or head of household? After determining how you file, you must determine your adjusted gross income – that’s your income after all deductions and credits. You then use that number to determine which tax bracket you fall into.

How Tax Brackets Are Used To Calculate Your Tax Liability

Here’s where the confusion lies. Many people mistakenly assume that if a pay raise causes them to cross over into a higher bracket, that higher rate applies to all their income. Fortunately, that isn’t the case – the higher rate only applies to the portion of your income that falls in that range.

Let’s say your taxable income (after deductions) is $39,000 and you are single. Your total income falls in range of the 22% tax bracket, or at least that’s how it looks, but in reality, only a portion of your income is subjected to the 22% rate. You pay the tax rate for each amount of income within the bracket. In this case, that means:

  • $9,700 is taxed at 10% ($970)
  • $29,300 is taxed at 12% ($3,516)

In this example, $4,486 of tax paid on $39,000 means the overall effective rate is 11.5%.

Now, let’s say you got a nice raise, and suddenly have $45,000 in taxable income (again, after deductions):

  • $9,700 is taxed at 10% ($970)
  • $29,775 is taxed at 12% ($3,573)
  • $5,525 is taxed at 22% ($1,215)

The highest bracket rate of 22% is only applied to the income that falls into that bracket. In this example, $5,758 of tax paid on $45,000 in taxable income puts the effective rate at 12.8%, which is higher than the previous example, but not much.

2020 Tax Brackets

Below are the tax brackets for the year 2020:

Individuals

Rate Taxable Income In Range
10% $0 to $9,875
12% $9,875 to $40,125
22% $40,125 to $85,525
24% $85,525 to $163,300
32% $163,300 to $207,350
35% $207,350 to $518,400
37% $518,400 and up

Married Filing Jointly

Rate Taxable Income In Range
10% $0 to $19,750
12% $19,750 to $80,250
22% $80,250 to $171,050
24% $171,050 to $326,600
32% $326,600 to $414,700
35% $414,700 to $622,050
37% $622,050 and up

Head of Household

Rate Taxable Income In Range
10% $0 to $14,100
12% $14,100 to $53,700
22% $53,700 to $85,500
24% $85,500 to $163,300
32% $163,300 to $207,350
35% $207,350 to $518,400
37% $518,400 and up

Your tax bracket affects how much money you owe in taxes at tax time. Remember that as your income rises, reaching a new bracket does not mean that your entire income will be subjected to the rate associated with the higher tax bracket. Fortunately, only a portion of your income total will be affected by the higher rate.

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