Updated on Tuesday December 1, 2020: Federal tax brackets for income earned in 2020, to be reported in 2021, are available. As expected, there aren’t major changes to them. For once, the number of brackets hasn’t changed, and they are the same as last year. It’s possible that the new administration may reshape the number of brackets and their breadth, but it is still too early for any details.
The size of the brackets changed slightly – more on that later. This is a common annual adjustment that factors in the inflation. As we get ready for the upcoming tax season, here is a snapshot of what to expect depending on your filing status.
Our federal tax system is called a progressive tax. It means that the more we earn, the higher the taxes we pay. The way it applies is that we pay different tax rates for the money that falls in different brackets. Essentially, not all our earnings are taxed the same, and the “first” dollars we earn enjoy the leanest taxes.
Here is how it works in practice. Let’s assume you are a taxpayer filing as single and your annual income is $70,000. For the purpose of this exercise, we’ll assume this amount is net of any credits and deductions. Even though $70,000 falls into the 22% bracket, the actual tax payment is calculated in the following manner:
So, how did we get here? As you can see, for taxpayers filing as Single, the first bracket goes from $0 to $9,875. So, the first $9,875 is taxed at 10%. The second bracket goes from $9,876 to $40, 125, which means that the next $30,250 is taxed at 12%. Lastly, the next bracket goes from $40,126 to $85,525, but since our earnings are only $70,000, the remaining $29,875 are taxed at 22%. All this leaves us with a total tax payment of $11,190 for the effective tax rate of 16%.
The tax brackets for the income earned in 2020 increased by 2%. As previously mentioned, it is to keep pace with inflation, and it is designed to keep the overall tax liability steady. If we consider the same example as above – a taxpayer filing as Single, with the taxable income of $70,000 – the same person last year would have paid nearly the same amount in taxes and ended up with the same effective tax rate.