Tax Brackets in AmericaThe United States of America follows a progressive method of taxation. This essentially means that if you fall in the higher income bracket, you will pay higher federal income tax.
However, it is not as black and white as that. Being "in" a tax bracket does not mean that you have to pay that particular Federal income tax rate on every penny that you make. This is where the progressive tax system plays a big role. People who have higher taxable incomes are usually subject to higher federal income tax rates and people who have lower taxable income are subject to lower tax rates.
It is the government who decides how much tax you owe them. Usually, your income is divided into chunks to calculate your tax amount. Each chunk of the amount is taxed at a corresponding rate. This works in the taxpayers' favor. No matter how much you earn and which tax bracket you fall in, you will never have to pay that tax rate on your entire income.
In 2018, the government declared seven tax slabs depending on your personal tax filing status as well as your income. The tax slabs are essentially 10%, 12%, 22%, 24%, 32%, 35% and 37%. The tax will vary depending on whether you are filing as single filer, married and joint filer, married but separate filer or head of the household filer.
For example - if you are a single filer or married but filing separately, your bracket will be 10% of your taxable income for income between $0 to $9,525. If you are married and filing jointly then this 10% applies to income between $0 to $ 19,050. If you are filing as the head of household then this 10% applies to income between $0 to $ 13,600.
Let us look at a few examples to illustrate the different tax brackets and how the progressive taxation system works.
For example - if you are a single tax filer with a taxable income of $32,000, as per the 2018 tax slab your rate of tax would be 12 percent. But you should not pay a 12 percent tax on the entire $32,000 amount. You pay only 10 percent tax on the first $9,525 and 12 percent on the balance amount.
Let us look at another example. If your taxable income is $50000 then as above you will pay a 10 percent tax on the initial $9,525. You then pay a 12 percent tax on the amount between $9,525 and $38,000 as per the 2018 tax slab. You then pay 22 percent tax on the remaining amount as it falls under that tax slab. If you calculate you will find that the total tax you pay amounts to around 14 percent of your taxable income even though you are actually in the 22 percent bracket. That is the power of progressive taxation.
The above applies only to federal income taxes. The tax brackets may vary depending on your state. Some states have a flat income tax structure while some states charge no income tax.
You could also apply a few methods to get into a lower tax bracket and pay a lower federal income tax. You can use both credits as well as deductions for the same.
Tax credits work in such a way that they reduce the amount of tax you owe the government. They do not change the tax bracket you fall into.
Tax deductions work on reducing your taxable income. Deductions essentially lower your taxable income by your highest federal income tax bracket percentage. So, a deduction of $1,000 if you are in the 22% tax bracket, saves you a tax amount of $220. You should try and make use of all the tax deductions that you can legally claim. They can help reduce your tax by quite a bit by reducing your taxable income and thus moving you into a lower tax bracket.