How tax brackets work

Being in the 24% tax bracket doesn’t mean you pay 24% on everything you make.

The progressive tax system means that people with higher taxable incomes are subject to higher tax rates, and people with lower taxable incomes are subject to lower tax rates.

The government decides how much tax you owe by dividing your taxable income into chunks — also known as tax brackets — and each chunk gets taxed at the corresponding rate. The beauty of this is that no matter which bracket you’re in, you won’t pay that rate on your entire income.

Being in the 24% tax bracket doesn’t mean you pay 24% on everything you make.

For example, let’s say you’re a single filer with $32,000 in taxable income. That puts you in the 12% tax bracket in 2018. But do you pay 12% on all $32,000? No. Actually, you pay only 10% on the first $9,525; you pay 12% on the rest.

These Tax Cuts and Jobs Act passed last year changed the tax brackets as well as the standard deduction.  The old 2017 tax bracket for this taxpayer was 15% meaning that he pays quite a bit less in 2018 than 2017.

If you are single and had $90,000 of taxable income, you’d pay 10% on that first $9,525, 12% on the chunk of income between $9,525 and $38,100, 22% on the income between $38,700 and $82,500 and 24% on the rest because, because some of your $90,000 of taxable income falls into the 24% tax bracket. The total bill would be about $15,890 — about 18% of your taxable income, even though you’re in the 24% bracket.  This is often referred to as your “effective rate”  as opposed to your “marginal rate.”

Under the new law, the “standard deduction” is going to make a big difference.  For a single filer, the deduction goes from $6,500 to $12,000.  For a married couple filing jointly the standard deduction goes from $13,000 to $24,000.  The increase in the standard deduction means that many people are no longer going to itemize.

 

Tagged , , , , ,
%d bloggers like this: