photograph of tax form 1040

What to Know about Tax Brackets and How They May Change

What are the income tax brackets and how do they work? Here is an overview.

Key takeaways:

  • There are seven tax brackets currently ranging from 10% to 37%
  • You don’t pay the same percentage on all your income; each portion of income is taxed at a different rate
  • The Biden Administration has said it wants to increase taxes for the wealthy, so it’s important to be prepared if this applies to you
  • You may be able to fit into a lower tax bracket by claiming credits and deductions

Paying taxes each year requires that you plan in advance for what you’ll owe, especially if you run your own business. A big part of a tax strategy is understanding the current tax brackets and how they may change in the future. These brackets mean that every American does not pay the same percentage of tax on their income each year; those who make less pay less, and those who make more pay more.

So, what are income tax brackets, and which one do you fall under? Here’s an overview of what tax brackets are, rates for 2021, what could change with the new Biden Administration, and how to get into a lower bracket. 

What are income tax brackets?

Tax brackets outline what percentage of income Americans have to pay based on their annual income. They were first created in 1913, when the top tax bracket was just 7 percent and the lowest was 1 percent. 

Today, there are seven total tax brackets. For tax year 2021, these range from 10% to 37%, according to the below guidelines, which have slightly higher income limits than 2020:

  • 10%: individual filers with income between $0 and $9,950; joint filers with income up to $19,900; and heads of household with income up to $14,200
  • 12%: individual filers from $9,951 to $40,525; joint filers between $19,901 to $81,050; and heads of household between $14,201 and $54,200
  • 22%: individual filers between $40,526 and $86,375; joint filers between $81,051 and $172,750; and heads of household between $54,201 and $86,350
  • 24%: individual filers between $86,376 and $164,925; joint filers between $172,751 and $329,850; and heads of household from $86,351 to $164,900
  • 32%: individual filers from $164,926 to $209,425; joint filers between $329,851 and $418,850; and heads of household between $164,901 and $209,400
  • 35%: individual filers between $209,426 and $523,600; joint filers from $418,851 to $628,300; and heads of household between $209,401 and $523,600
  • 37%: individual filers and heads of household making $523,601 or above and joint filers with $628,301 or more

This tax bracket system is a “progressive tax” approach, again meaning that people making more money pay more in federal income taxes. However, keep in mind that just because you fall into one of these tax brackets doesn’t mean that you are taxed that rate on every penny you make. Each portion of income is taxed at the corresponding rate.

For example, if someone makes $60,000 in 2021, the first $9,950 of that income is taxed at 10%, the portion from $9,951 to $40,525 is taxed at 12%, and the rest is taxed at 22%.

What could change under the new administration?

With each new U.S. administration comes potential new tax laws and priorities. The Biden Administration has indicated that it will implement higher taxes on wealthier Americans, so if you make over $400,000 in income each year, you may see an increased rate. This may mean that top rate could get a boost up to 39.6% from 37%.

This online tax calculator can help you plan for taxes if Biden’s plans go into effect in the near future.

The new administration has also proposed other tax changes outside of brackets, including an increase to the child tax credit (up to $3,000 from $2,000), and an increase in the child and dependent care credit (up to $8,000 from $3,000).

How to fit into a lower tax bracket

If you’re worried about paying a lot when tax season rolls around again, there are a few ways you can reduce your burden. First, deductions lower taxable income, so with enough of them, you may be able to get down into a lower bracket. Common deductions are charitable donations, medical expenses, mortgage interest, home office expenses, vehicles, and student loan interest, among others.

The other option is taking advantage of tax credits. These don’t impact which bracket you’re in, but they reduce the amount you must pay. Credits you may be eligible for include the child tax credit, the earned income tax credit, or the residential energy credit, though there are many others. 

You can potentially lower your tax burden significantly with these strategies. This is why it’s crucial to work with a tax professional who can help you claim all credits and deductions you’re eligible for.

Work with a tax professional to save more money

Each year, there are new laws and guidelines to know and implement while planning. Make sure you never miss anything by working with a tax professional who knows each new regulation or legislation, in addition to what might be coming next. 

The team at Provident CPA and Business Advisors is ready to help you with everything tax-related. Contact us to learn more about our business growth and strategic tax services.

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