How Do Tax Brackets Work?
Hello reader tax year is around (If you are reading in Jan/Feb/March).Taxes generally gets you confused, but i have to say they are not that bad. Let me break and explain how taxes work for individuals and families (Not for business).
What are taxes?
Taxes are something you pay to your local/state/federal government so government can run the country by providing infrastructure, schooling, and other basic needs.
How does it work?
It is very basic that you make a certain amount of money in a given year (Jan 1 – Dec 31), depending on how much you make you will pay a percent of your earnings to the federal government. Depending on which state and city you pay state and local taxes, some states like Texas, Washington, Alaska, New Hampshire, Wyoming, etc. doesn’t have state tax.
Let’s take an example, let’s say uncle sam makes $100,000 a year, he won’t straight away pay taxes for $100,000, Every year IRS gives a standard deduction for which you won’t pay any taxes, so for the year 2021 IRS standard deductions for a single individual is $12,550 and if that single person is head of the household that standard deduction is $18,800. Assume uncle sam is the head of the household, now his taxable income came down to $100,000 – $18,800 = $81,200.
Uncle Sam might not be taxed for $81,200 yet, uncle sam is very forward-looking and he is saving into his employer sponsor 401K or his personal IRA every year, the annual limit for 401K is $19,500 for 2021, so uncle sam saves $10,000 into 401K plan. Now his taxable income came down to $81,200 – $10,000 = $71,200.
so the final taxable income is $71,200, so there will be federal, state, medicare+medicaid, and social security tax all will be applied to this amount. Medicare, Medicaid, social security, state taxes (many states) have a fixed percentage of taxes doesn’t matter how much you make.
We will see how much federal tax will uncle sam pay for $71,200 taxable income. For FY 2021 the tax brackets for a single individual are below.
| Rate | For Unmarried Individuals | For Married Individuals Filing Joint Returns | For Heads of Households |
|---|---|---|---|
| 10% | Up to $9,950 | Up to $19,900 | Up to $14,200 |
| 12% | $9,951 to $40,525 | $19,901 to $81,050 | $14,201 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 $164,900 |
| 32% | $164,926 to $209,425 | $329,851 to $418,850 | $164,901 to $209,400 |
| 35% | $209,426 to $523,600 | $418,851 to $628,300 | $209,401 to $523,600 |
| 37% | Over $523,600 | Over $628,300 | Over $523,600 |
| Source: IRS |
For uncle sam, we will refer to the last column (For Heads of Households), for the first $14,200 he will be taxed 10% which is $1420, the remaining will be $71,200 – $14,200 = $57,000, for the next amount up to $54,200 i.e $40,000 ($54,200-$14,200) he will be taxed at 12% which will be $4800, the remaining will be $57,000-$40,000 = $17,000 for the remaining $17,000 he will be taxed at the rate of 22% which comes down to $3740.
So the total tax for an income of $100,000 uncle sam will be pay $1,420 + $4,800 + $3,740 = $9,960 which came down to nearly 10% for federal and the state and other tax will be seperate.
When politicians say they will raise taxes for an average person earning up to $170,000 that change will not affect.
Frequently Asked Questions
How do tax brackets work?
U.S. brackets are marginal — only the dollars within each bracket are taxed at that bracket's rate. Earning more never reduces your take-home from earlier brackets. Your average tax rate stays well below the top marginal rate.
Will a raise push me into a higher tax bracket and reduce my pay?
Only the amount above the bracket threshold is taxed at the higher rate, so a raise always increases take-home. The 'I don't want a raise' myth is mathematically incorrect. Run the math before turning down extra income.
How can I reduce the income that hits higher brackets?
Pre-tax 401(k), HSA, and traditional IRA contributions reduce taxable income directly. Charitable giving, business expenses, and deductible losses also lower the tax base. A few hours of planning can save thousands.
