The Ins and Outs of Tax Brackets and Rates

When filing your taxes, most individuals see the current tax bracket system as a mystery and are often left scratching their heads over how much tax they actually owe. The system may seem complicated, but with the help of a tax professional or accountant, such as Bhatia & Co, INC, CPAs in Santa Clara, CA, you can determine how much your tax liability will be. However, your tax professional can also assist you in finding eligible deductions that can reduce your taxable income and thus reduce your tax liability.

The Number of Tax Brackets

While it might be hard to imagine, your income can be taxed at more than 28 possible rates. There are determined by the seven federal income tax brackets, 10, 15, 25, 28, 33, 35 and 39.6 percent. In addition, there are four different filing status, which are outlined below:

• Single – Applies to unmarried individuals
• Married filing jointly – For married individuals that are combining their income to file a single tax return
• Married filing separately – This is for married individuals who choose to file their own individual federal income tax return
• Head of household – This filing status is for individuals that are considered single for filing purposes, but provide more than half the support for a child and then claim that child as an exemption

Once you determine your filing status, it then narrows down what tax brackets will apply to your income. So what is a tax bracket?

Simply put, a tax bracket includes two different amounts, one that is the base amount and the other is the ceiling amount. Thus, if your income reaches the base amount, then you will be taxed for a portion of your income at that rate. There are also two other terms that you need to know:

• Marginal Tax Rate – The marginal tax rate is based on your last dollar of income and is the highest bracket your income is taxed at. For example, if someone makes $200,000, then their marginal rate would be 33 percent.
• Effective Tax Rate – The actual tax rate you pay on all of your income. This combines all the tax rates together, essentially serving as your average tax rate across all the brackets that apply to you.

So how does this all work? Your income is taxed at different rates along the way. Essentially, the more money you make, the higher the tax will be on the upper portion of your income. Therefore, the more tax brackets you pass through, the higher your effective rate will end up being.

The IRS provides a current table to assist you in determining how much of a tax liability you have based on the tax brackets you are passing through. If you have any questions about these tables, work with a tax professional, who can explain exactly how they work for your circumstances.

Deductions and Taxable Income

The brackets apply to your taxable income, so for many high earners, the best way to reduce their tax bracket level is to reduce their taxable income. Using deductions, one can bring down the amount of tax liability they may owe.

However, keep in mind that spending time finding a variety of deductions might be more cost effective for individuals with an overall higher income than those who might only make it to the 15 percent tax bracket. When you reach income over $100,000, for example, you will find that those deductions will save you significantly more than those who might have only reached $30,000 in taxable income.

So what income is always taxed at the highest rate? It is the extra income that might be earned above your normal salary. For example, if you are paid for a consulting job, then the funds from that job will be taxed at your highest rate. Therefore, you should put aside that percentage of the extra funds to be sure to cover the tax liability from that additional income.

For those who might find themselves getting a raise or bonus throughout the year, it is important to strategize with your tax professional to determine deductions and credits that you might be eligible for to reduce your taxable income and thus reduce your tax liability.

Click on the link below to connect with one of the tax professionals or accountants at Bhatia & Co, Inc, CPAs in Santa Clara, CA, who can work with you to determine your tax bracket and also the applicable deductions that could assist you in reducing your taxable income.