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Taxes are on a lot of folks’ minds as we progress into 2022. The tax deadline for the 2021 tax year is looming (April 15), and unlike the past two years, it does not appear that taxes for 2021 will get a deadline extension. The first step for many Americans is to figure out which of the seven federal tax brackets they will be placed in. These tax brackets have the following rates: 10%, 12%, 22%, 24%, 32%, 35% and 37%.
There are many variables that affect these rates. For example, if you are eligible for federal tax deductions, you may be put into a lower tax bracket than your income suggests. If you earn money through a business or an investment, you may be taxed at a level that differs from the income tax bracket. This article looks to provide the reader with more knowledge about federal income taxes for the tax years of 2021 and 2022.
How Do Tax Brackets Work?
While taxes can get complicated, it is important to understand the general framework of the federal government’s progressive tax system. This means that higher-income earners will pay a higher percentage in taxes. Conversely, lower-income earners will pay a smaller percentage of their income to the federal income tax. The idea behind the progressive tax system is to give low-income earners more tax relief while having a larger burden fall on higher-income earners who may have a better capacity to pay these higher rates. With this foundation in mind, there are a few caveats that will affect what tax bracket an individual falls into.
What are the Federal Income Tax Brackets for 2022?
While many are currently concentrating on the 2021 tax year, it is not too early to look ahead to the federal income tax brackets in 2022. Tax brackets tend to be adjusted upwards each year to account for inflation. As you can see in the chart, the percentage of tax you owe will depend on your filing status and your taxable income. Single, married, and head of households are the designations an individual chooses to file their taxes by. The chart below provides detailed information on taxes owed by filing status.
See the full tax brackets for 2022
What is a Progressive Tax System?
As previously mentioned, the United States operates under a progressive tax system, meaning the percentage you pay in taxes increases as your income increases. There are some intricacies to this system that are important to keep in mind.
First, the federal government taxes income based on the bracket that income is eligible for. There are currently seven federal tax brackets, so as an individual earns more during a year, they will be bumped up to their corresponding tax bracket.
A common misconception with federal income taxes is that individuals pay one tax rate on all of their income. This would be the case in a flat tax system, but because America uses a progressive tax, individuals’ tax rates will be assessed based on the bracket of the specific income they earn. Individuals earning under the threshold of the first tax bracket will only be taxed at one rate (10%), while individuals earning above the threshold of the top bracket will have their annual income tax at all of the seven different rates.
It is important to keep in mind that not all income is taxed at these rates. Income from long-term investment returns, interest, and dividends are taxed between 15-20%. Business tax will be different as well. This is a subject for another time!
What is a Marginal Tax Rate?
The marginal tax rate is the method of taxation that is used in a progressive tax system. As explained above, individuals’ incomes are taxed throughout the year based on the bracket their income is in. A marginal tax rate means that the tax rate for a high-earning individual will be increased to match their amount of income amassed in the calendar year. An individual earning $800,000 in 2022 will “graduate” from the lowest tax bracket to the highest tax bracket as his income keeps increasing.
A marginal tax rate differs from a flat tax rate, as a flat tax rate is a listed percentage that an individual will pay on all of their income. Understanding proper terminology with taxes can save individuals time and money. It is important to understand key concepts like tax deductions and tax credits that can offer individuals tax relief.
Examples of Federal Income Tax for Single Filer
To better understand America’s progressive income tax system, we will use a concrete example. Let’s take an individual who made $32,000 in income in 2021. This is for an individual who chose the single filing designation. While the individual’s income falls into the 12% tax bracket, not all of this income is taxed at 12%. Remember that America has a progressive tax system, so this individual’s income would be taxed at both 10% and 12%. The first $9,950 would be taxed at a 10% rate. The next $22,500 would be taxed at the 12% tax bracket. The true tax rate for this individual would fall between 10% and 12%.
For someone making $50,000 in a calendar year and filing single, they have an extra tax bracket to deal with. Again, the first $9,950 is also taxed at the 10% rate. The next $30,575 is taxed at 12%, and the final $9,475 is taxed at the 22% rate. Most of the taxes paid by the $50,000 earner are at the 12% rate. At the same time, the individual earning $50,000 is being taxed at a higher overall rate than the individual making $32,000. As individuals earn more income in the progressive tax system, their income throughout the year will be taxed within more brackets and ultimately have a higher overall rate than lower-earning individuals.
How do I get into a Lower Federal Income Tax Bracket?
After reading more about how the progressive tax system works, many readers will want to figure out how to lower their tax burden. Tax strategies become especially important for individuals who are in higher tax brackets. While a detailed tax plan may need to be personalized for the individual, there are core tax concepts all income earners can keep in mind.
Tax deductions are perhaps the most common way for individuals to lower their tax burden. A tax deduction is an expense that the federal government deems eligible to lower one’s taxable income. For example, if an individual has a taxable income of $100,000 but has $10,000 in expenses that qualify as tax deductions, that individual will only be taxed on $90,000 ($100,000-$10,000=$90,000). Examples of expenses that qualify for federal tax deductions are health insurance premiums, state sales tax, and state income tax.
Tax planning can be a complicated process for many individuals. Having professional help to navigate the current tax landscape can be very beneficial. For more information on professional tax relief, check out some of the top tax relief companies, and compare possible options with tax relief company reviews.
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Taxes
Jackson is a consultant for a large American Asset Manager, notable clients include Morgan Stanley, Merrill Lynch, and Wells Fargo. He also writes on financial topics, including bitcoin, personal finance, and portfolio construction. Avid skier during the cold New England winters.
