In the United States, we have a progressive tax system based on tax brackets. How these tax brackets work is something that is commonly misunderstood.
In today’s article, I will explain how tax brackets affect you so you’ll have the knowledge to make informed decisions about your income and taxes.
Anna Smith, a Senior Accountant with The Accountants for Creatives provides us with a simple guide and explanation of the 2022 Tax Brackets and Federal Income Tax Rates.
What’s a progressive tax system?
Like many countries, America’s federal tax system is called progressive. Unlike when using the term “progressive” in other circles, when we’re talking about taxes, it’s not actually anything to do with new or liberal ideas. Having a progressive tax system just means that the more income you have, the higher your tax rate (and tax burden) will be.
How do tax brackets work?
Even though a progressive tax system means that higher tax rates are applied to higher income amounts, that doesn’t mean that the higher tax rate applies to all of that income. This is the common misconception many people have. Let’s look at an example to help illustrate how our progressive tax system works using marginal tax brackets.
In 2022, my client, Meg, made $100,000 in income. She was allowed the standard deduction of $12,950 putting her taxable income at $87,050. She’s a single filer, so here’s how she was taxed by the IRS:
2022 Tax Rate for Single Filer
| Single Filer | Income Bracket | Amount Owed |
|---|---|---|
| 10% | $10,276 to $41,775 | 10% x $10,275 = $1,027.50 |
| 12% | $10,276 to $41,775 | 12% x $31,500 = $3,780 |
| 22% | $41,776 to $89,075 | 22% x $45,275 = $9,960.50 |
| Total Tax Burden | $14,768 |
You can see that Meg did not pay the 22% income tax on all of her income. She only paid the 22% tax rate on the amount of her income that fell into the 22% bracket, which means she paid 22% of $45,275 in that bracket. This is her marginal tax rate. The marginal tax rate is the tax rate you pay on an additional dollar of income. So when you hear people say things like, “I paid a ton more money in taxes last year because I fell into a higher tax bracket,” that’s really not an accurate portrayal of how tax brackets work.
Let me show you another example so you have a good idea of what happens if you do fall into a higher tax bracket. Let’s say Meg got a raise of $5,000. Her taxable income increased to $92,050. Again, she’s a single filer, so here’s how she was taxed by the IRS:
2022 Tax Rate for Single Filer
| Single Filer | Income Bracket | Amount Owed |
|---|---|---|
| 10% | $10,276 to $41,775 | 10% x $10,275 = $1,027.50 |
| 12% | $10,276 to $41,775 | 12% x $31,500 = $3,780 |
| 22% | $41,776 to $89,075 | 22% x $47,300 = $10,406 |
| 24% | $89,076 to $170,050 | 24% x $2,975 = $714 |
| Total Tax Burden | $15,927.50 |
Through these two examples you can see that even if you bring in enough income to move to a higher tax bracket (good for you!), only the part of your income that falls into that higher tax bracket will be taxed at the higher rate. Think of each bracket as different size piggy banks. The 22% bracket can only fit up to $47,300 ($89,075 – $41,775). Only part of the raise that Meg got can fit into the 22% bracket and the rest goes into the next size up, 24%..
You may hear people say that they ended up bringing home less money because they fell into a higher tax bracket and had to pay more in taxes than they received from their raise. Now you know that is a misconception. If you make more money, you will pay more in taxes, but you will still bring home more money than you did before.
Looking at Meg’s income for the year, you’ll see that when she had $87,050 in taxable income, she would have paid about 16.96% in taxes. When she got the raise and her taxable income increased to $92,050 (which is in the “24% tax bracket”), she only paid about 17.3% in taxes. That is her effective tax rate.
2022 Tax Rate for Single Filer
| Salary | $100,000 | $105,000 |
|---|---|---|
| Taxable Income After Deductions |
$87,050 | $92,050 |
| Effective Tax Rate | 16.96% = $14,768 | 17.3% = $15,927.50 |
| Take Home Pay | $85,232 | $89,072.50 |
She still brought home a considerable amount of her raise even though she fell into a higher tax bracket.
It’s also good to know that the IRS adjusts the tax brackets every year to account for changes in cost of living and inflation. Since we typically have inflation each year, the tax brackets move up in amount each year.
How do tax brackets affect me and my tax decisions?
Knowing which tax bracket you fall into can help you make smart tax choices. If you want to lower your taxable income and your tax burden, here are some actions you can consider:
- Contribute more to your retirement account. Some contributions for the previous tax year can be made all the way up until April 15th of the following year, so that’s a good option for those who won’t know their total income until later in the year.
- If your income is higher, you may save in taxes by itemizing your deductions rather than taking the standard deduction.
- Contribute more to 529 college savings and prepaid plans.
- If you have a flexible spending account (FSA) for your healthcare or dependent care costs or a health savings account (HSA), contribute more tax-free dollars to those accounts.
- Talk to an accountant about other ways you can lower your taxable income and maximize your tax deductions and tax credits.
No matter what you hear others say, it just doesn’t make sense to avoid making more money just so you can avoid paying more in taxes. Now that you know how tax brackets work, you can make informed decisions about your taxes and maybe even help explain tax brackets to your friends and family.
