Taxes may be one of the few certainties in life, but when it comes to understanding how they work, it’s normal to feel, well, uncertain.
Earlier this month, the IRS released updates to the tax code for tax year 2020, including higher income limits on tax brackets to account for inflation, which will affect how much you pay in income taxes when you file in 2021.
Not sure how these changes will impact your future tax bill? Here’s a look at the 2020 tax brackets and what they mean. (Round your income to the nearest dollar.)
Tax Brackets For Tax Year 2020
Single filers:
10%: Up to $9,875
12%: Income of $9,876 to $40,125
22%: Income of $40,126 to $85,525
24%: Income of $85,526 to $163,300
32%: Income of $163,301 to $207,350
35%: Income of $207,351 to $518,400
37%: Income over $518,400
Married, filing jointly:
10%: Up to $19,750
12%: Income of $19,751 to $80,250
22%: Income of $80,251 to $171,050
24%: Income of $171,051 to $326,600
32%: Income of $326,601 to $414,700
35%: Income of $414,701 to $622,050
37%: Income over $622,050
Married, filing separately:
10%: Up to $9,875
12%: Income of $9,876 to $40,125
22%: Income of $40,126 to $85,525
24%: Income of $85,526 to $163,300
32%: Income of $163,301 to $207,350
35%: Income of $207,351 to $311,025
37%: Income over $311,025
Heads of household:
10%: Up to $14,100
12%: Income of $14,101 to $53,700
22%: Income of $53,701 to $85,500
24%: Income of $85,501 to $163,300
32%: Income of $163,301 to $207,350
35%: Income of $207,351 to $518,400
37%: Income over $518,400
Wondering about tax brackets for 2019? Take a look at them here.
Understanding 2020 Tax Brackets
Taxes aren’t exactly the most straightforward concept, and a lot of people misunderstand how they’re taxed according to these brackets. For example, you might think that if you’re single and earn $70,000 in 2020, all your income is taxed at 22%. That’s not the case.
“The United States has a progressive tax system. This means that tax rates increase as a taxpayer’s income increases,” said Logan Allec, a certified public accountant and owner of personal finance blog Money Done Right. He explained that only the income that falls within a particular tax bracket’s range is taxed at that corresponding rate.
Another thing to keep in mind that tax brackets only apply your taxable income, which is what’s left over after subtracting your standard or itemized deductions, plus any other adjustments, according to Allec.
Let’s look at an example: Say that after all your deductions are taken, you are left with $55,000 in taxable income for the year. Following the tax brackets above, the first $9,875 of income is taxed at 10%, meaning you will pay $987.50 on that amount.
Your next $30,250 of income (that is, the income between $9,876 and $40,125) is taxed at 12%, meaning you will pay $3,630 on income falling in this range.
Finally, the remaining $14,875 (the income above $40,125) is taxed at 22%, meaning that you will pay $3,272.50 on this income. Add up all those tax amounts ($987.50 + $3,630 + $3,272.50), and you end up with a total tax liability of $7,890.
Marginal vs. Effective Tax Rate
To better understand tax brackets and how they impact your taxes for the year, there are a couple of numbers it’s helpful to know, according to Scott Newhouse, a certified financial planner who teaches tax planning at California State University, Northridge.
The first is your marginal tax rate. This is essentially the highest tax rate that you paid. In our example above, the highest tax rate you would pay on $55,000 in taxable income is 22%. “Another way of saying this is that your marginal tax rate is the tax rate you paid on the last dollar that you earned,” Newhouse said.
Next is your effective tax rate, which is the most telling number in terms of your bottom line. This is the average tax you paid on all of your income, according to Newhouse. Going back to our example, if you paid a total of $7,890 on $55,000 of income, your effective tax rate would be 14.3%. So as you can see, just because you fall into the 22% tax bracket (your marginal tax rate), it doesn’t mean you actually pay 22% of your income in taxes.
“I would recommend that all taxpayers figure out where they stand in terms of these two numbers,” Newhouse said. “It will give you a good idea of what tax rates you’re paying, and it could also help you maximize tax strategies.”
For instance, if you are in a really high tax bracket today, it might make sense to contribute to a traditional IRA, Newhouse said. This way, your contributions would be made pre-tax, lowering your taxable income for the current year. Then your money would grow until you’re ready to make withdrawals in retirement (and pay taxes on them), at which point you’d hopefully be in a lower tax bracket.
Of course, the tax strategy you follow is dependent on your specific situation and goals. Even so, “knowing these two terms, and knowing your rate on each of them, will help you make the best decisions for your situation and maximize tax strategies available to you,” Newhouse said.
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