Some people believe that if they earn more money, they pay more in taxes and will have less money than if they would have earned less. After reading this article, you will soon find out that this is not true. Depending on your individual situation, taxes can be very complex and it may make sense to avoid a certain tax bracket if possible.
The United States has a progressive tax system, which can be complex and confusing. Depending on your income, different amounts are taxed at different rates. As a result of this, you will pay a lower percentage of taxes than your current tax bracket.
Breaking Down Taxes
Each level of your income is taxed at a different rate. Below is the current IRS tax brackets for your 2020 taxes.
| Tax Rate | Single Filer | Married/Jointly Filing |
|---|---|---|
| 10% | $9,875 or less | $19,750 or less |
| 12% | $9,875.01 - $40,125 | $19,750.01 - $80,250 |
| 22% | $40,125.01 - $85,525 | $80,250.01 - $171,050 |
| 24% | $85,525.01 - $163,300 | $171,050.01 - $326,600 |
| 32% | $163,300.01 - $207,350 | $326,600.01 - $414,700 |
| 35% | $207,350.01 - $518,400 | $414,700.01 - $622,050 |
| 37% | Over $518,400 | Over $622,050 |
Source: IRS
How the Progressive Tax System Works
Let’s assume Greg makes $85,525 a year. As a single filer, Greg is in the 22% tax bracket. This does not mean Greg will pay 22% on all his income. Instead, Greg pays 10% on his first $9,875, 12% on the amounts from $9,875 – $40,125 and 22% on amounts above $40,125. While Greg’s marginal tax rate is 22%, his effective tax rate is 17% of his taxable income.
| Tax Bracket | Taxable Income | Tax Rate | Taxes Paid |
|---|---|---|---|
| $9,875 or less | $9,875 | 10% | $987.50 |
| $9,875.01 - $40,125 | $30,250 | 12% | $3,630.0 |
| $40,125.01 - $85,525 | $45,400 | 22% | $9,988.0 |
| Total Taxes | $14,605.50 |
Lauren marries Greg and now their combined annual income is $414,700. As a married filer, they are in the 32% tax bracket. While their marginal tax rate is 32%, their effective tax rate is 23% of their combined taxable income.
| Tax Bracket | Taxable Income | Tax Rate | Taxes Paid |
|---|---|---|---|
| $19,750 or less | $19,750 | 10% | $1,975 |
| $19,750.01 - $80,250 | $60,500 | 12% | $7,260 |
| $80,250.01 - $171,050 | $90,800 | 22% | $19,976 |
| $171,050.01 - $326,600 | $155,550 | 24% | $37,332 |
| $326,600.01 - $414,700 | $88,100 | 32% | $28,192 |
| Total Taxes | $94,735 |
Use the Tax Code
Using the tax code can further reduce your tax liability if you are able to make certain deductions such as interest on student debt, interest on your mortgage, charitable contributions, retirement plan contributions, etc.
Knowing your income tax bracket and state will help you calculate how much you will save in taxes, assuming you itemize your deductions.
Always remember that your marginal tax rate only applies to a portion of your income, and your effective tax rate is the actual rate you pay.