The IRS issues new tax deductions, credits, and changes regularly. Inflation adjustments are a regular change that can affect your tax returns. For the tax year 2020, you probably would have filed the tax returns already. The IRS has issued inflation-adjusted tax credits and deductions for the tax year 2021.
These changes will impact the tax returns that you’ll file in 2022. Some of the important changes will be around the CARES act exemptions that will expire this year.
Let us take you through the tax brackets and see how they work.
Tax Brackets for the Tax Year 2021
The tax year 2021 starts from January 1, 2021 and ends on December 31, 2021. You’ll file these taxes in 2022 with a normal tax deadline of April 15, 2022.
Under the Tax Cuts and Jobs Act (TCJA), there are no exemptions for personal tax filers. For the tax year 2021, the exemption remains zero too.
There are seven tax brackets for tax filers in the US. These tax brackets work on an incremental/progressive basis. It means as your net income grows, your tax bracket will be higher.
|Tax Rate||Individuals||Married – Joint||Married – Separate||Head of Household|
|10%||$9,950 or less||$19,900 or less||$9,950 or less||$14,200 or less|
|12%||$9,951- $ 40,525||$19,901- $ 81,050||$9,951- $ 40,525||$14,201- $ 54,200|
|22%||$40,526 – $86,375||$81,051 – $172,750||$40,526 – $86,375||$54,201 – $86,350|
|24%||$86,376 – $164,925||$172, 751 – $ 329,850||$86,376 – $164,925||$86,351- $164,900|
|32%||$164,926 – $ 209,425||$ 329,851 – $ 418,450||$164,926 – $ 209,425||$164,901 – $ 209,400|
|35%||$209,426 – $523,600||$ 418,451 – $ 628,300||$209,426 – $314,150||$209,401 – $523,600|
|37%||$ 523,601 and Above||$ 628,301 and Above||$314,151 and Above||$523,601 and Above|
Note: Some individuals may have to pay taxes on the Alternative Minimum Taxable (AMT) basis. The AMT rates are currently 26% and 28%. The AMT uses an alternative definition of taxable income to stop tax avoidance by the rich taxpayers. It can also help the lower-income taxpayers to avoid double taxation.
The exemptions for AMT are given in the table below.
|Filing Status||Exempted Amount|
|Married-Filing Separately||$ 57,300|
|Trust or Estate||$ 25,700|
Inflation Adjustments for Tax Year 2021 – Filed in 2022
The IRS adjusts the taxable income, exemptions, deductions, and credits for taxpayers annually for inflation. For instance, the taxable income with the first slab of 10% for individuals in the year 202 was $9,850. It has been adjusted for inflation and is set at $ 9,875. Similarly, all other tax brackets are adjusted for inflation.
The tax rates for all seven slabs remain the same as 10%, 12%, 20%, 22%, 24%, 32%, and 37%.
Inflation adjustments for tax exemptions and credits can lower the tax bill. However, the net effect on the tax liability for the taxpayers would depend on the income and expense adjustments for inflation.
Progressive Structure of Tax Brackets
Income tax authorities can impose a simple flat tax structure, a regressive, or a progressive structure for tax collections. The US tax authorities impose a progressive tax structure on taxpayers. It means your tax liability will increase as your income increases.
A progressive tax structure means the tax rate will increase with increased income. For example, if you are earning $ 600,000 annually as an individual, you’ll get through each tax bracket. Similarly, someone earning around $ 12,000 annually would go through only the first two tax brackets.
For simplicity, taxpayers can calculate an average tax rate rather than calculating marginal rates. Effectively, all taxpayers can calculate the average tax rates by dividing all taxable income by the tax payable amount. It can give you an idea of your total tax liability as well as the net tax rate that the Federal government imposes on your taxable annual income.
How Do Tax Brackets Work? With Examples
Let us understand the progressive tax bracket structure with the help of examples. As we have seen above, the tax rate gets higher as the taxable income increases.
Example # 1:
Suppose as an individual your annual taxable income is $ 35,000. It means you fall under the tax bracket of 12%. You do not pay a flat tax rate; hence you will not pay a direct 12% of $35,000. ($ 4,200).
You pay 10% on the first $ 9,875. It comes to $987.50.
For the next $25,125, you’ll pay 12%. It comes to $ 3,015.
Hence your total Tax Liability will be $ 4,002.50.
Example # 2:
Suppose your annual taxable income for a married joint filing is $150,000. It puts you in the third tax bracket of 22%. With a flat tax rate, you would’ve paid 22% of $150,000 is $ 33,000.
Your first $ 19,900 will be taxed at 10%. It equals $ 1,990.
The next $ 61,1150 ($ 81,050 – $ 19,900) will be taxed at 12%. It equals $ 7,338.
The third $ 68,950 ($ 150,000 – $81,050) will be taxed at 22%. It equals $ 15,169.
Hence, your total Tax Liability will be $ 24,497. The average tax rate becomes 16.33%.
As we can see in both examples, the taxpayer would have paid higher taxes under a flat tax rate structure. Although the US imposes an incremental tax structure, it does not necessarily mean higher taxes.
On the other hand, some experts argue that a flat tax rate structure would mean lower tax rates. That could lower the tax liability for many taxpayers ending up in higher tax brackets. However, it could potentially put lower-income taxpayers at a disadvantage of paying higher net taxes with a flat tax rate.
Capital Gains Taxes
Taxpayers’ income from the long-term capital gains is taxed at a different tax rate. There are two tax brackets for capital gains taxes, first for 15% and the second for a 20% tax bracket.
For individuals, the capital tax gains of $40,400 will be taxed at 15% and 0% below it.
For Married-Joint filers, the capital tax gains of $80,800 will be taxed at 15%.
For the head of household, the capital tax gains of $ 54,100 will be taxed at 15%.
Capital gains below these amounts will be charged at 0%. Capital gains above these limits will be taxed at 20% rates. A similar progressive tax structure calculation rule applies here too.
Standard deductions can lower your tax liability. These deductions can help you lower a tax bracket as well. It means if you are in a tax bracket of 24%, a standard deduction of $1,000 that pushes you to a 22% tax bracket can save you $240 in the tax liability.
Standard Deductions for:
Individuals = $ 12,550.
Married Filing jointly = $ 25,100.
Married filing separately = $ 12,550.
Head of household = $ 18,800.
The standard deduction amount for a dependent person cannot exceed $ 1,100 or a sum of $350 and the individual earned income credit (but should not exceed the regular standard deduction amount).
How to Lower your Tax Brackets – Credits and Deductions
You can reduce the tax liability by using either tax credits or deductions. As we have seen above, deductions can lower your tax bracket. Tax credits can lower your net tax liability.
Let us discuss a few key tools to fully utilize the progressive tax brackets and lower your tax liability.
Earned Income Tax Credit – EIC
The EIC amount for the year 2021 has also been adjusted for inflation. It will be $ 6,728 for married taxpayers filing jointly with three or more children. For married couples, the phase-out amount begins at $ 25,470 and ends at $ 57,414.
For the tax year only, the tax credit for earned income tax credit for a childless couple increases to $ 1,502. The special increase is due to the American Rescue Plan signed by the Biden Administration.
Child Care Tax Credit
The age limit for child care tax credit has been increased from 16 to 17 years. The tax credit amount has also been increased to $ 3,000 per child. For children under 5, the tax credit will be $ 3,600.
The IRS uses Modified Adjustable Gross Income (MAGI) formula to check eligibility of child care tax credit. For qualifying taxpayers, the number of MAGI will be:
- Single – $ 75,000.
- Married filing jointly – $ 150,000
- Head of Household – $ 112,500.
The tax credit for Qualified Adoption and Child with Special needs will be $ 14,400 for the tax year 2021.
Retirement Plan Contributions
The special rules for retirement plans and contributions with increased waivers will end after the tax year 2020 unless enacted again by law. Taxpayers should keep in mind the normal retirement plan contribution limits and other contributions such as medical savings accounts.
The income exclusion limit for SIMPLE retirement accounts is set at $ 13,300. For retirement plans such as 401 (k), 403 (b), and 457, the exclusion amount is set at $ 19,900. The catch-up amount for individuals aged 50 or above is set at $ 6,500.
For Medical Savings Accounts with self-only coverage, the annual plan deductible amount should not be less than $ 2,400 and no more than $ 3,600.
Additionally, taxpayers can think of conventional itemized deductions and above-the-line-item deductions to lower the tax brackets and net tax liability.
- Medical and Dental Expenses
- Home mortgage interest
- Student loan interest
- Charitable donations
- Foreign earned income exclusion.
References for Research Work:
Credits & Deductions for Individuals | Internal Revenue Service (irs.gov)
The information provided is for educational purposes only and is not intended as investment advice for anyone. All information discussed is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The views presented today are those of WealthCare Financial and do not necessarily represent the views of AlphaStar Capital Management, LLC. The opinions expressed are subject to change without notice and do not constitute financial, legal or tax advice. Please consult your financial professional before executing any financial strategy. Investment Advisory and financial planning services are offered through AlphaStar Capital Management, LLC, an SEC registered investment adviser. AlphaStar and WealthCare Financial are independent entities