I remember my first (legit) paycheck.
I was working at a restaurant as a banquet waiter earning something around minimum wage in New York in the late 90s. The banquets were only a few years so the paycheck was around $30 a shift. I had probably six shifts a week? So I had expected my first paycheck to be a little over $150 (this place deducted an amount for “food,” assuming you'd eat something there… which was a scam because no one ate anything during their shift, you were too busy!)) but it was just over $100 after withholding and FICA.
That was my lovely introduction to taxes.
What's always tricky about taxes in the United States is how complicated they are to understand. You have deductions, credits, exemptions, carryovers, … the list goes on and on. Even if you knew every last deduction (and that would make you a tax accountant or a weirdo!), you'd still only know half the story.
Today, we will explain away one piece of the tax puzzle – the tax brackets. The brackets and the deductions (standard and itemized) are the two values that tend to change from year to year. They are not pegged to inflation or cost of living, but the IRS “manually” adjusts them every year to account for them. There are other credits and deductions that automatically change based on the Consumer Price Index released by the Bureau of Labor Statistics.
So how do the tax brackets and deductions work?
Federal Income Tax Brackets
Federal income tax is a progressive tax system. This means that you are taxed at a higher rate when you earn more.
It's also a marginal tax system. Every dollar you earn is taxed differently.
The 100,000th dollar is taxed more than your 1st dollar. And these taxes are assessed on your adjusted gross income. That's your total income minus deductions.
Here are the federal income tax brackets:
|Tax Bracket||Single||Married Filing Jointly||Head of Household|
|10%||$0 – $9,525||$0 – $19,050||$0 – $13,600|
|12%||$9,526 – $38,700||$19,051 – $77,400||$13,601 – $51,800|
|22%||$38,701 – $82,500||$77,401 – $165,000||$51,801 – $82,500|
|24%||$82,501 – $157,500||$165,001 – $315,000||$82,501 – $157,500|
|32%||$157,501 – $200,000||$315,001 – $400,000||$157,501 – $200,000|
|35%||$200,001 – $500,000||$400,001 – $600,000||$200,001 – $500,000|
If you file “Married Filing Separately,” here is your table (broken out due to sizing):
|Tax Bracket||Married Filing Separately|
|10%||$0 – $9,525|
|12%||$9,526 – $38,700|
|22%||$38,701 – $82,500|
|24%||$82,501 – $157,500|
|32%||$157,501 – $200,000|
|35%||$200,001 – $300,000|
If you're single and you make $50,000 minus deductions, exemptions, etc; you would pay:
- 10% on the first $9,525 = $952.50
- 12% on the next $29,175 = $3,501
- 22% on the last $11,300 = $2,486
You'd pay a total of $6939.50 in taxes on $50,000 of income, or 13.879%.
Your effective tax rate is just under 14% but you are in the 22% tax bracket. The next dollar you earn is taxed at 22%.
That's just part one. Not every dollar you earn is actually taxed. 🙂
With our tax system, your income is reduced by your deductions. You can take the standard deduction or you can itemize your deductions. When you itemize deductions, you may have to provide proof that you had those expenses. Itemized deductions are things like your mortgage interest, charitable contributions, student loan interest, deductible taxes, and many others.
When you take the standard deduction, you don't have to do anything. You just take it. The amount is based on your filing status.
Here are the 2018 standard deductions (with 2017 figures for reference, things changed quite a bit with the recent tax law!):
|Your Filing Status||2018||2017|
|Married Filing Jointly||$24,000||$12,700|
|Married Filing Separately||$12,000||$6,350|
|Head of Household||$18,000||$9,350|
What I always find interesting is when someone says “It's fine to pay a mortgage because the interest is tax deductible.” While technically true, it's not accurate.
To claim an itemized deduction, you would have had to spend money in the first place. You can claim the standard deduction without having to spend a penny.
If you had a choice between paying $10,000 in mortgage interest (deductible) or $10,000 in rent (not deductible), you wouldn't prefer one over the other. In both cases, you're paying $10,000 but you'd still claim the standard deduction (assuming no other itemized deductions).
There may be other reasons to carry a mortgage, but taxes isn't one of them.
In previous years, there was a personal exemption that reduced your income.
It's gone for 2018. And gone for 2019. It's out until 2025.
In 2017, that amount was $4,050 and it phased out. Once your AGI peaked $261,500 (or $313,800 for married filing jointly), it would start to phase out. You would claim that exemption for everyone in your family, including dependents. So a family of four would have four personal exemptions.
Since the latest tax law doesn't expire until 2025, the personal exemption may be gone for a while. This was offset by an increase in the standard deduction, though that is little solace to folks who regularly itemize their deductions.
Single vs. Head of Household
Ever wonder what the difference was between a single filer and a head of household filer? The head of household filing status seems to very much like a single filer except you get a few higher amounts, like an $18,000 standard deduction versus the single filer's $12,000 deduction.
To be considered the head of household filing status, you must:
- Pay more than half the household expenses,
- Be “considered unmarried” for the tax year,
- Have a qualifying child or dependent.
The first rule is straightforward – you have to pay more than half the household expenses. These include utility bills, mortgage or rent, insurance, groceries, etc.
The second rule is actually slightly trickier. You have to file a separate return from your spouse, pay for more than half the cost of home upkeep, not live with your spouse during the last six months of the tax year, have the qualifying person consider your home as their main home for the last 6 months of the year, and claim that person as a dependent.
Finally, the third rule is the same rules governing qualifying child or dependents throughout tax law.