Each year, the Internal Revenue Service (IRS) updates their marginal income tax rates. In other words, they issue new tax brackets for the year ahead to reflect the ongoing impact of inflation. For 2021, there are seven income tax brackets in the United States: 10%, 12%, 22%, 24%, 32%, 35% and 37%. These will be important when it comes time to do your taxes next Spring. The brackets are considered to be “marginal,” which means that different portions of your income will be taxed at different rates. We’ll explain that in more detail shortly. First, let’s talk about the upper and lower tax brackets for 2021.
Top Tax Rates
For 2021, the top tax rate is 37%. Before you panic, you should know that it’s only applied to individual taxpayers with incomes of more than $523,600 (or $628,300 for married couples who file a joint return). Single filers with incomes over $209,425 ($418,850 for married couples in a joint filing) will hit the 35% tax bracket.
The 32% bracket covers single filers with an income exceeding $164,925 ($329,850 for married couples filing together). Meanwhile the 24% bracket applies to incomes over $86,375 for singles ($172,750 for married couples). The vast majority of Americans (over 80%) make less than $150,000 per year.
The Lowest Brackets
Single taxpayers with incomes exceeding $40,525 (or married couples who are over $81,050 together) are placed in the 22% marginal tax bracket. Meanwhile, the 12% bracket applies to incomes over $9,950 for single taxpayers ($19,900 for married people filing jointly).
The lowest tax rate is 10%. It only applies to singles with income under $9,950 ($19,900 for married couples). The IRS has also increased the standard deduction for 2021, giving it an inflation boost. What is the standard deduction, we hear you asking? Let’s discuss it further.
Here’s everything in a handy table:
|Tax Rate||Single||Married (Filing Jointly)|
|10%||$0 to $9,950||$0 to $19,900|
|12%||$9,951 to $40,525||$19,901 to $81,050|
|22%||$40,526 to $86,375||$81,051 to $172,750|
|24%||$86,375 to $164,925||$172,751 to $329,850|
|32%||$164,926 to $209,425||$329,851 to $418,850|
|35%||$209,426 to $523,600||$418,851 to $628,300|
|37%||$523,601 and higher||$628,301 and higher|
The standard deduction is a flat dollar amount that reduces the amount of your income that is subject to tax. The standard deduction for single taxpayers in 2021 will be $12,550. That’s up $150 from 2020′s level. For married couples, the standard deduction is $25,100, reflecting a $300 increase from the previous tax year.
Heads of households will also get a bump to their standard deduction, up to $18,800 ($150 more than last year). There is no personal exemption for 2021, as it was eliminated in the Tax Cuts and Jobs Act, the overhaul of the U.S. tax code that took place in 2018 under the previous presidential administration.
Marginal Tax Rates
A marginal tax rate is the percentage of tax you have to pay on each dollar of taxable income you earn. This typically equates to what is known as a “tax bracket.” For example, if you’re a single filer with $30,000 of taxable income, you would be in the 12% tax bracket. That means you pay 12% tax on your income over $9,950, and 10% on the income below that amount.
If you had $41,000 of taxable income instead, much of it would still fall within the 12% or 10% tax brackets. However, that last few hundred dollars over $40,525 would be taxed at 22%. People often make the mistake of thinking that just sneaking into the next bracket causes their entire income to be taxed at a higher rate, but that’s not how it works.
It’s only the amount of adjusted gross income you earn which falls into each specific bracket. You can claim deductions and credits to reduce your adjusted gross income and tax liability, respectively, potentially causing you to fall into a lower tax bracket.
How the Tax Brackets Work
Suppose you’re single and have $90,000 of taxable income in 2021. Since $90,000 is in the 24% bracket for singles, would your tax bill be a flat 24% of $90,000 – or $21,600? No, it would not. It’s more accurate to refer to tax brackets as “tax pockets,” if we’re being honest. That’s because different portions of your income are likely going to be taxed at different rates.
Don’t get sucked into the false thinking that earning a higher income will actually result in you having less money overall, once you pay a higher tax rate. If you’re offered a raise, you shouldn’t turn it down simply because your overall tax bill will increase. Likely, the extra income will push up your overall income up, despite you possibly earning money to have part of your new income fall into a higher tax bracket — but not all of your income.
The system doesn’t work like that, and is specifically designed to only tax you at higher rates once you meet certain income thresholds. As previously stated, it’s almost impossible to earn more money (from a raise, bonus, or overtime, for example) and end up with less to spend at the end of the year, after your tax return is finished.
In our example above, you would not have to pay $21,600 in taxes. Using the marginal tax rates, your first $9,950 would be taxed at 10%. That’s $995 in total. You income from $9,951 to $40,525 would be taxed at 12%. That’s about $3,669 in taxes. The next pocket is from $40,526 to $86,375, which is taxed at 22%. That equals another $10,087 in taxes owed. Finally, the income from $86,376 up to $90,000 would be taxed at 24%. That’s only $3,624 in income, and only $870 more in taxes.
Add it all up and your tax liability is only $15,621. That’s much less than $21,600, which is what 24% of $90,000 would be. As you can see, you will likely have to pay multiple tax rates, depending on your income level. For a more in-depth explanation of tax brackets and how they work, check out this article.
The difference between bracket ranges sometimes creates what’s known as a “marriage penalty.” This penalty impacts certain married couples who file a joint return, typically where the spouses’ incomes are similar. Under the marriage penalty, couples pay more tax than they would if they were single.
The penalty is triggered when the minimum taxable income for the joint filers’ tax bracket is less than twice the minimum amount for the single filers’ bracket. Today, only the top tax bracket contains the marriage penalty. As a result, only couples with a combined taxable income over $628,300 are at risk when filing their 2021 federal tax return. For 2020 returns, the marriage penalty was possible only for married couples with a combined taxable income above $622,050. In other words, probably no one reading this article needs to worry about the marriage penalty.
Future Top Rate
Will the top income tax rate go up in the future? The answer is likely yes. As part of his American Families Plan, President Biden has proposed increasing the highest tax rate from 37% to 39.6%. That was actually where it was before the Tax Cuts and Jobs Act of 2017 was enacted.
The proposed 39.6% rate would apply to single filers with taxable income over $452,700 and joint filers with taxable income exceeding $509,300. President Biden has said that the rise in the top tax rate is part of his administration’s effort to ensure that wealthy Americans pay their fair share when it comes to income taxes. Whether you believe that millionaires (and billionaires) should contribute more of their immense wealth in taxes is a matter of personal politics, we suppose. Just remember that when left-leaning politicians talk about raising the tax rate, it’s typically only referring to the incomes of the ultra wealthy, and not the average American just trying to support themselves and their family.
How To Get Into A Lower Tax Bracket
The two most common ways of reducing your tax bill are Credits and Deductions. Tax credits directly reduce the amount of tax owed, although they don’t affect what bracket you’re in. Tax deductions, on the other hand, reduce how much of your income is subject to taxes on a dollar-to-dollar basis.
Generally, deductions lower your taxable income by the percentage of your highest federal income tax bracket. So, if you fall into the 22% tax bracket, a $1,000 deduction could save you $220. It’s important to claim all the tax deductions available to you. They can reduce your taxable income and move you into a lower bracket. Ultimately, that means you’ll pay less in federal taxes.
The Bottom Line
Which tax bracket you fall into (and how much tax you ultimately pay) depends on your income and tax situation. The more you earn, the higher your tax brackets will go. Obviously, that means you’ll pay more tax too. Understanding which tax bracket you fall into (and how marginal tax rates will impact you financially) is important to achieving your long-term money goals.
Keep in mind that there are ways to lower your tax liability through credits and deductions. If you don’t have much experience with these things, consult a tax professional. They will advise you which expenses you might be able to write off as deductions or which credits you are eligible to claim. Let’s face the facts here: it sucks paying taxes, but it’s also a fact of life. Make sure you take the proper time to understand the latest tax brackets, how they impact you, and what steps you can take to only pay the minimum amount of taxes required of you. Planning ahead is the only way to stay ahead of the Taxman.