The United States has what’s called a progressive federal income tax system. As a person’s income increases, the taxation percentage progressively goes up. When asking, “How do I know what tax bracket I am in?” Step One is to look at the current IRS charts.
There are seven federal tax brackets, with each bracket containing a range of incomes that would be taxed at that rate. These can change from year to year.
There are also four filing categories: single; head of household; married, filing jointly; and married, filing separately.
This is the information for money earned in 2020 and that applies for federal taxes due in April 2021 or in October 2021 for people who file an extension.
Related: A guide to tax-efficient investing
Single
Tax rate of:
- 10% for people earning $0 to $9,875
- 12% for people earning $9,876 to $40,125
- 22% for people earning $40,126 to $85,525
- 24% for people earning $85,526 to $163,300
- 32% for people earning $163,301 to $207,350
- 35% for people earning $207,351 to $518,400
- 37% for people earning $518,401 or more
Married, Filing Jointly
- 10% for people earning $0 to $19,750
- 12% for people earning $19,751 to $80,250
- 22% for people earning $80,251 to $171,050
- 24% for people earning $171,051 to $326,600
- 32% for people earning $326,601 to $414,700
- 35% for people earning $414,701 to $622,050
- 37% for people earning $622,051 or more
Married, Filing Separately
- 10% for people earning $0 to $9,875
- 12% for people earning $9,876 to $40,125
- 22% for people earning $40,126 to $85,525
- 24% for people earning $85,526 to $163,300
- 32% for people earning $163,301 to $207,350
- 35% for people earning $207,351 to $311,025
- 37% for people earning $311,026 or more
Head of Household
- 10% for people earning $0 to $14,100
- 12% for people earning $14,101 to $53,700
- 22% for people earning $53,701 to $85,500
- 24% for people earning $85,501 to $163,300
- 32% for people earning $163,301 to $207,350
- 35% for people earning $207,351 to $518,400
- 37% for people earning $518,401 or more
Effective Tax Rate vs. Marginal Tax Rate
The percentages listed in the tax chart — 10%, 12%, 22%, 24%, 32%, 35% and 37% —are called “marginal tax rates.” Through the most recent tax reform, five of those rates were lowered between 1% and 4%.
A person doesn’t just take their income and apply the rate in the chart, though, and then pay that amount of tax. The federal income tax system is more complex. Part of that complexity includes what’s called the “effective tax rate,” which can provide a better sense of what taxes might be owed for a calendar year.
The effective tax rate is the average of the various rates you’ll pay on increments of your income after taking any deductions that you’re entitled to. The vast majority of Americans claim the standard deduction rather than itemizing.
For income earned in 2020 (with taxes filed in 2021), the standard deduction is $12,400 for single people and for those who are married, filing separately; $18,650 for heads of household; and $24,800 for married, filing jointly.
To calculate an effective tax rate:
- Choose the appropriate filing category and year—say, married, filing jointly.
- Find the income range that contains the relevant income earned for that category—$150,000, for example.
- Subtract the standard deduction from that amount.
In the example just described, the married couple filing jointly would be in the 22% bracket ($150,000 – $24,800 = $125,200, which falls into the range of $80,251 to $171,050).
Note that none of the information in this post is intended to serve as legal or financial advice. For advice on your specific situation, consult your attorney or tax professional.
Deductions and Tax Credits
Tax deductions can reduce the amount of income upon which taxes are owed. So, if a person’s tax bracket was 24% and a $500 deduction applies, that saves that person $120 in taxes. Potentially tax deductions can include interest on a home mortgage, applicable charitable donations and so forth.
If the total of the itemized deductions is greater than the standard deduction, the taxpayer can choose to itemize, which can mean paying less in income taxes that year and sometimes getting a refund.
Not all deductions apply to all situations, so it’s important for each taxpayer to make sure deductions taken are applicable to their tax situation. This is an area where a tax professional can provide guidance.
Tax credits reduce the amount owed on taxes in a direct, dollar-for-dollar way (in contrast to deductions, which work on a percentage basis). So if a taxpayer can take a $500 tax credit, that saves them $500 (vs. the $120 saved by a taxpayer in the 24% percent bracket who could take a $500 deduction).
Some tax credits are refundable; others are not. If a taxpayer would otherwise owe $400 at tax time but could take a $500 tax credit:
- With a nonrefundable tax credit, that person would owe nothing because the tax credit can’t trigger a refund.
- With a refundable tax credit, they would receive a $100 refund.
Income Tax Credits
Some of the income tax credits available for 2020 include:
- Earned Income Tax Credit. This is a refundable type of credit that’s available for people who meet eligibility requirements, which include earning a low to moderate income.
- Child Tax Credit. Families must have at least one qualifying child who is under the age of 17 and otherwise meet qualifications. For each qualifying child, the maximum tax credit allowable is $2,000. This is an example of a tax credit that’s a combination of a refundable and a nonrefundable one, with $1,400 refundable for each qualifying child.
- The American Opportunity Tax Credit. This is partly refundable and can help taxpayers who are paying for higher education—for themselves, a spouse, or a dependent. The Lifetime Learning Credit is another form of higher education credit.
The IRS provides an Interactive Tax Assistant tool to help taxpayers determine if they qualify for tax credits.
Paying Taxes on Stocks
Investors may need to pay taxes on stocks held in their investment portfolios.
For example, if shares of stock are sold — and the value has increased (appreciated) since their purchase — the difference in value is called a capital gain, and is taxable.
Other times, investors may sell a stock at a price that’s lower than the purchase price. In those cases, a capital loss has taken place. These can be deducted from capital gains earned, which may reduce the amount of taxes the investor would owe.
If the stocks were sold within a year of the date of purchase and have an appreciated value, that’s considered a short-term capital gain. If it has been more than a year since the stock was purchased, that’s considered a long-term gain.
Tax rates are much higher for short-term gains. Short-term capital gains are taxed as regular income, using the investor’s tax bracket. By referring to the tax charts included in this post, it can be determined what the marginal tax rate would be on short-term capital gains.
Long-Term Capital Gains
Long-term capital gains, meanwhile, aren’t taxed for single filers making $40,000 or less or married couples who are filing jointly and made $80,000 or less. Other tax rates for long-term gains are as follows:
- Single filers making $40,001 to $441,450: 15%
- Single filers making $441,451 or more: 20%
- Married couples filing jointly and making $80,001 to $496,600: 15%
- Married couples filing jointly and making $496,601 or more: 20%
Income tax may be owed by investors owning stock even if no shares are sold. This can happen if an investor receives dividends from a company that earned a profit. If the dividends are significant enough, the investor may need to pay income taxes on them.
Investors who receive dividends should receive a 1099-DIV tax form for each investment or stock. This can help to determine how much is owed in taxes.
Typically, taxes are not owed for gains gleaned from buying and selling stocks when they are invested in an IRA or a 401(k) as long as withdrawals are not made. This, again, is a scenario that should be discussed with a professional.
This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.
