The United States maintains a progressive personal
income tax, which means you pay an increasingly higher rate of tax as you make more money. The system manifests itself via
tax brackets, which are illustrated below for tax year 2021.
| TAX RATE |
SINGLE FILERS TAX BRACKETS |
HEAD OF HOUSEHOLD TAX BRACKETS |
MARRIED FILING JOINTLY OR QUALIFYING WIDOW TAX BRACKETS |
MARRIED FILING SEPARATELY TAX BRACKETS |
| 10% |
$0 to $9,950 |
$0 to $14,200 |
$0 to $19,900 |
$0 to $9,950 |
| 12% |
$9,951 to $40,525 |
$14,201 to $54,200 |
$19,901 to $81,050 |
$9,951 to $40,525 |
| 22% |
$40,526 to $86,375 |
$54,201 to $86,350 |
$81,051 to $172,750 |
$40,526 to $86,375 |
| 24% |
$86,376 to $164,925 |
$86,351 to $164,900 |
$172,751 to $329,850 |
$86,376 to $164,925 |
| 32% |
$164,926 to $209,425 |
$164,901 to $209,400 |
$329,851 to $418,850 |
$164,926 to $209,425 |
| 35% |
$209,426 to $523,600 |
$209,401 to $523,600 |
$418,851 to $628,300 |
$209,426 to $314,150 |
| 37% |
More than $523,600 |
More than $523,600 |
More than $628,300 |
More than $314,150 |
Source:
Internal Revenue Service
Understanding Tax Brackets
The system works in a fairly straightforward fashion. For a single taxpayer, a tax of 10% is levied on each dollar of income earned up to a limit of $9,950. Then, a tax of 12% is levied on each incremental dollar of income earned up to a limit of $40,525. The trend continues on until you reach $523,600 of income. Above this level, all incremental income earned is taxed at a rate of 37%.
Based on this foundational knowledge, let’s briefly explore a few real world scenarios via the following questions and answers:
If you recently got a new job that places you into a new tax bracket, what should you know about moving up a tax bracket?
Moving up to a new tax bracket means that your effective tax rate will increase. Essentially, you will pay a higher average tax rate. Generally, your net income will increase, but the government will be getting a higher proportion of it.
How does moving up a tax bracket impact the way you file taxes, budget, and save money?
Moving up to a new tax bracket means your fiscal situation has changed. You are making more money, but are now subject to a higher effective tax rate. Generally, this results in more net income and greater savings potential, assuming you maintain a disciplined
budget.
Does a tax bracket affect all your income?
The tax brackets are designed to facilitate an increasingly higher rate of taxation as you make more money. All dollars of income earned are taxed, but at different rates.
Does moving into a new tax bracket mean you have a lower net income?
Moving up to a new tax bracket means that your effective tax rate will increase. Essentially, you will pay a higher average tax rate. Generally, your net income will increase, but the government will be getting a higher proportion of it.
We all want to make more income, but, unfortunately, this usually means moving up to a higher tax bracket. That said, in some situations, this can be managed via the implementation of tax shelters, which are strategies designed to legally reduce your income. They take various forms and comprise an array of tax deductions, tax credits and investment vehicles.
If implemented properly, a tax shelter can help you achieve an optimal outcome — an enhanced lifestyle and a lower tax bracket. As always, it’s best to consult a tax professional before making any decisions that can affect your financial health.