Tax planning is an important part of your financial plan. As discussed in a previous blog, tax planning can save you a bunch of money each year with a little bit of knowledge and guidance. One of the first steps in tax planning is to know your tax rate now so that you can plan on how to maximize your savings in the future. To help, we’ve put together a quick primer on US tax rates and how to quickly calculate yours.
What is a Tax Bracket?
The United States government uses a system of progressive tax rates. That means that the higher your taxable income, the higher the tax rate that applies to you. In other words, people who make more money should pay more in taxes. Rather than a sliding scale of tax rates, the IRS has a set of seven so-called tax brackets which state the tax rate that applies to a range of incomes. There are currently seven federal tax brackets. For a single person, or a married person filing separately these are;
10% – $0 – $9,875
12% – $9,876 – $40,125
22% – $40,126 – $85,525
24% – $85,526 – $163,300
32% – $163,301 to $207,350
35% – $207,351 to $518,400
37% – $518,401 or more
Making Sense of Tax Brackets
Your tax rate is not simply determined by the tax bracket your entire income falls in. Instead, to determine the total amount of tax you owe, your income is broken down into chunks and taxed at the appropriate rate for each chunk. For example, if your taxable income is $100,000, the tax you owe would be;
($9,875*10%) + ($30,250*12%) + ($45,400*22%) + ($14,475*24%) = $18,080 or a tax rate of about 18%.
Taxable Income vs. Total Income
Of course, it is uncommon for people to pay tax on the entire amount of their income as deductions and credits can be applied to reduce the amount of your income subjected to tax. The adjusted amount of income after applying credits and deductions is your taxable income, and it is always lower than your total income.
Knowing Where to Start
Once you know your taxable income, you have a starting point for tax planning in which you can explore a variety of credits and deduction that can further reduce the tax you’ll owe. You can’t plan for the future if you don’t know where you are today, so take some time to figure it out!
E&Y Agency is an insurance brokerage and tax preparation firm serving clients in Troy, Michigan and the surrounding area. Call us to talk about tax planning in advance of the next tax season, and let us help you find ways to plan ahead and minimize your tax liability.
