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I'm going to explain how tax brackets work. Oftentimes people make a big mistake when trying understand tax brackets and it can cost them a lot of money. Not only will I explain how tax brackets actually work, but I will show you how income tax works as well. By explaining income tax you can understand how the tax brackets work, then you will understand how taxes work so can make sure you are not paying higher taxes.
IRS Website With Tax Brackets: https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2021
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I'm gonna break down how tax brackets work and why this one misunderstanding can be costing you millions of dollars. So let's jump right in. Quick disclaimer, I'm not a CPA, this is not financial advice, you should always speak to your financial advisor, CPA or accountant before making any decisions. Okay, let's get into it. First, I want to explain how tax brackets work. Before I get into how people end up leaving so much money on the table, I'm going to be showing you the tax brackets for an individual filing single, so you can see how it works. I'm going to be using the 2021 tax brackets in my example. So once you see how this works, if you're using another tax bracket like married filing jointly, you'll be able to apply it the same way. I'll put a link to the IRS website in the show notes below. If you want to check it out. The first thing to note is there is a standard deduction. The standard deduction is the amount that can be subtracted from your income before income taxes are applied. This is used if you don't itemize your taxes. Generally, people only itemize the total amount of their deductions if it's more than the standard deduction. What I'm going to show you works either way, just if you were itemizing them, then the income taxes would start after the amount itemized. However, in the example, I will just be using the standard deduction in 2021. According to the IRS website, the standard deduction for an individual filing single is $12,550. That is the amount that you get tax free. Therefore, if your total income is less than this amount, you wouldn't owe income taxes for an individual filing single 10% is up to $9,950 12%, up to $40,525 22% is up to $86,375 24% is up to $164,925 32% is up to $209,425 35% is up to $523,600 37% Is anything over $523,600. So this highest tax bracket and 2021 for an individual filing single is 37%. As a good example, let's use a person that makes $125,900 per year. And before you tune out and say this is not applicable to me because I don't make near that much money. Stick with me because you'll see how this applies to you. Now if you look at the tax brackets, you would see that this person is in the 24% tax bracket, I want you to comment below if you think this person will be paying 24% taxes on their income. Now, most people think that once you're in the 24% tax bracket that you'll be paying 24% on the full $125,900. This is a huge misconception. First you will take the $125,900 and subtract the standard deduction which is $12,550. This leaves you with $113,350. This is your taxable income. The next tax bracket is the 10% bracket and your tax up to $9,950. So only this $9,950 will be taxed at 10%, which is only $995. When you subtract the $9,950. You're now left with $103,400. So first, we're gonna look at the difference in the amounts between the brackets by subtracting the $9,950 from the $40,525 the taxable amount and the 12% tax bracket is $30,575. So only this amount is taxed at 12% which is $3,669. We will then subtract the amount that was taxed which was $30,575 and that leaves you with $72,825. Now we're gonna look at the difference between the next tax bracket by subtracting $40,525 from $86,375 which leaves you with $45,850. This is the only amount that is taxed at 22% which is $10,087. We will now subtract the amount that was tax which was $45,850 and that leaves you with 26,975 dollars, we will again look at the difference between the next tax bracket by subtracting $86,375 from $164,925, which leaves you with $78,550. However, we only have a remaining $26,975 of income. So only this amount will be taxed at 24%, which is $6,474. As you can see, all of your money is not taxed at the highest tax bracket, you pay taxes only as your money moves through the brackets, and you only pay taxes on dollars within that tax bracket. oceGtRvvLLY |