Benjamin Franklin said there are two things that you can't avoid in life: death and taxes. That may be true, but at least death doesn't happen to you once a year.
We just passed that time of year when Americans have to file their taxes (April 18, 2022, for most taxpayers). For many, it was a stressful and confusing process. But it doesn't have to be!
Income tax brackets: What you need to know
Income tax brackets are simply the ranges of income that you are taxed at different rates. The IRS uses a progressive tax system, which means that as your income increases, so does your marginal tax rate.
There are seven tax brackets in the United States: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The bracket you fall into depends on your taxable income and filing status.
However, you could end up in a different tax bracket for 2022 than you were in 2021. That's because the tax brackets are adjusted for inflation every year. This avoids 'bracket creep', which is when people are pushed into higher tax brackets simply because their incomes have increased with inflation. The IRS typically announces these adjustments in October or November of the previous year.
How are tax brackets calculated?
As we mentioned before, the IRS uses a progressive tax system. This means that as your income increases, so does your marginal tax rate. The marginal tax rate is the rate you pay on your last dollar of income.
For example, let's say you are a single taxpayer with a taxable income of $50,000. Your marginal tax rate in 2021 would be 22%, which is the rate you would pay on your last dollar of income.
However, that doesn't mean that you would pay a 22% tax on your entire $50,000 of income. In fact, you would only pay 10% on the first $10,275 of your income, 12% on the next $31,500, and 22% on the last $8,225 (not considering exemptions, etc. on your tax return).
This brings us to another important concept: effective tax rate. The effective tax rate is the overall percentage of your income that you pay in taxes.
For our single taxpayer with a taxable income of $50,000, the effective tax rate would be less than 22%. This is because, even though the marginal tax rate is 22%, the average tax rate (including all seven brackets) is only 14.4%.
What do the different filling statuses mean?
There are four filing statuses that you can choose from when you file your taxes: single, married filing jointly, head of household, and married filing separately.
Your filing status is determined by your marital status and whether or not you have any dependents. The IRS uses different criteria for each filing status to determine who can use it.
- If you are unmarried and have no dependents, you will likely file as a single taxpayer.
- If you are married and file a joint return with your spouse, you will file as a married couple.
- If you are unmarried but have one or more dependents (children or parents), you will likely file as head of household.
- And finally, if you are married but choose to file separate tax returns, you will file as married filing separately.
What is the Standard Deduction?
The standard deduction is a set amount that you can deduct from your taxable income if you do not itemize your deductions. The standard deduction reduces your taxable income and, as a result, your tax liability. The standard deduction for married couples is double the standard deduction for single filers. But if you and your spouse don't have many deductions, you may end up paying more taxes by filing separately.
What is the Marriage Penalty?
The marriage penalty is when two people who are married and file their taxes jointly end up paying more in taxes than they would if they were single.
This quirk of tax law happens when the tax brackets for married couples filing jointly are not double the tax brackets for single filers. For 2022, the marriage penalty will only affect couples with incomes over $647,850.
In fact, the first six tax brackets are exactly the same for both single and married filers. However, keep in mind that your State income tax brackets may be different from the federal tax brackets, and could trigger the Marriage Penalty.
Get expert advice on filing your taxes
As you can see, there are a lot of factors that go into determining what tax bracket someone falls under. If the idea of filing taxes sounds stressful for you and your spouse, then we encourage you to please reach out to us for a free consultation. Our fee-only financial advisor is happy to offer guidance on the best way to file your taxes and help you understand the tax implications of your financial situation.