Tax status and brackets


There’s a two-step process for determining the rate at which you pay income tax.

The income tax you owe the federal government depends on two factors: your filing status and the highest of the seven possible tax brackets into which a portion of your taxable income falls.

There are five categories of filing status:

  • Single
  • Married
  • Married filing jointly
  • Married filing separately
  • Head of Household
  • Qualifying widow(er) with dependent child

You must follow IRS guidelines in selecting the one that most accurately reflects your situation as of December 31 of the tax year. Some options can save you money, such as filing as head of household instead of single, if you qualify. Others may cost more, such as filing separately rather than jointly if you’re married.

Taxable income is divided into seven brackets with floors and ceilings set annually – and generally adjusted upward each year to account for inflation. In fact, there are really three sets of seven brackets: one set for married filing jointly and qualifying widow(ers), one set for head of household, and one for single and married filing separately.

The rate you pay

Each bracket is taxed at a different rate, with the lowest rate — 10% — applying to the bottom bracket and the highest rate — 39.6% — applying to the top bracket. The rates for the other brackets in 2016 are 15%, 25%, 28%, 33%, and 35%. The portion of your income that falls into each bracket is taxed at the rate for that bracket.

For example, if the last dollar of your taxable income falls into the 28% bracket, you’d pay some tax at 10%, some at 15%, some at 25%, and some at 28%. The top rate at which you pay is called your marginal rate. That’s in contrast to your effective rate, which you calculate by dividing your total tax by your taxable income. Your effective rate is always lower than your marginal rate.

Different tax bites

As an example of how the system works, a hypothetical single taxpayer with a taxable income of $120,000 would pay $26,637 in taxes for tax year 2016, crossing four tax brackets. Her marginal rate is 28%, and her effective rate is 22%. A married coupled filing a joint return with the same $120,000 of taxable income would owe $21,543 across three tax brackets. That’s a marginal rate of 25% and an effective rate of 18%.

In contrast, if each person of a married couple earned $120,000, for a joint total of $240,000 they would owe $54,613, or $1,339 more than if each of them were single. Their marginal rate would be 33% and their effective rate 23%. Married couples who file separate returns may pay at higher marginal and effective rates because the income ranges for each bracket are smaller than for either single or joint filers.

Alternative minimum tax

The alternative minimum tax (AMT) is a parallel tax system that was created to ensure that high-income taxpayers couldn’t avoid paying their fair share of taxes by capitalizing on the loopholes. It hasn’t actually worked that way, as many loopholes still exist. But what has happened is that the AMT increasingly affects middle-income taxpayers with perfectly legitimate but higher-than-average exemptions or deductible expenses. These include state and local taxes, mortgage interest, or rental income. To determine what you owe, you must figure your tax both ways and pay the higher amount.

State and local taxes

Everyone who earns income in the United States, and US citizens who earn income elsewhere in the world, must pay federal income taxes. You also pay state taxes unless you reside in of the seven states that don’t collect them: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. Two others – New Hampshire and Tennessee – tax interest and dividend income but not earned income.

The good news is that you can deduct state and local income taxes you’ve paid when you file your federal tax return, provided you itemize your deductions. That helps to reduce your taxable income, though it may make you vulnerable to the AMT.

Other types of taxes

All but five states — Alaska, Delaware, Montana, New Hampshire, and Oregon — and many local governments charge sales tax on the value of most or all of the goods and services you pay for. And most states or local governments levy property taxes on the value of real estate or personal property, or both.  These taxes pay for public services, such as the public school system and police, fire, and sanitation services.

Federal and state governments also charge excise taxes on the manufacture, sale, or use of certain products, such as tobacco, petroleum products, alcohol, car rentals, and hotel rooms.

The federal government imposes gift and estate taxes on assets transferred from one owner to another if the total value of those assets reaches a certain limit. In 2017, it’s $5,490,000. The exceptions are gifts to qualifying charitable organizations and to spouses who are US citizens. However, annual gifts of up to $14,000 to an individual are federally tax free. (Both those limits will be adjusted for inflation over time.) Some states also have estate or inheritance taxes.

 

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