| Applying 2023 Tax Brackets and Rates to an Individual Earning $80,000 | |||
|---|---|---|---|
| Dollars | Amount Subject to Tax | Tax Rate | Tax at Each Rate |
| $0 to $11,000 | $11,000 | 10% | $1,100 |
| $11,001 to $44,725 | $33,724 | 12% | $4,047 |
| $44,726 to $95,375 | $35,274 | 22% | $7,760 |
| Total | $80,000 | $12,907 total tax bill | |
Because of the varying tax brackets, a taxpayer will usually have an effective tax rate different from their highest tax bracket. The marginal tax rate is the additional tax paid for every extra dollar of income. For example, a 10% marginal tax rate means that $.10 of every next dollar earned will be taken as tax.
However, note that while the marginal rate in the example above is 22%, the effective tax rate is 16.1%. This figure is arrived at by dividing the total tax bill ($12,907) by income ($80,000) and multiplying by 100. The effective tax rate corresponds to what the individual ends up paying in taxes to the government.
How to Reduce Your Taxes: Tax Deductions
There are two ways to pay less tax: make less money or earn more tax benefits. As it’s usually more advantageous to seek out tax benefits, there are several specific places taxpayers can look.
Tax deductions are legislative enactments that allow a taxpayer to reduce the taxable income used to calculate their tax liability. Tax deductions don’t directly reduce the amount of tax a taxpayer must pay.
For example, consider a taxpayer who contributes to a traditional IRA. In many situations, the taxpayer is allowed to deduct their contribution from their taxable income.
Should the taxpayer have contributed the 2023 maximum amount, their taxable income would have been reduced by $6,500. If the taxpayer was in the 22% marginal tax bracket, this would have resulted in a potential $1,430 ($6,500 * 22%) tax savings.
Examples of Tax Deductions
The most common federal tax deduction used to reduce your federal income tax liability is the standard deduction. Each taxpayer may claim a standard deduction based on their filing status. This amount (which is reassessed annually) allows a taxpayer to reduce their taxable income by a set amount established by the federal government.
The alternative to a standard deduction is the itemized deduction. This option allows taxpayers to accumulate certain types of eligible expenses and opt to deduct the total allowable amount of these expenses instead of the standard deduction. These types of expenses include charitable contributions, mortgage interest payments, and medical expenses.
Last, there are deductions exclusive of the standard deduction or itemized deduction. For example, as long as taxpayers meet specific contribution and income limit thresholds, certain types of retirement contributions may be deducted. Alternatively, taxpayers may receive deductions on other types of spending such as educational expenses.
The standard deduction for tax year 2024 is $14,400 for single filers and $29,200 for married couples filing jointly.
How to Reduce Your Taxes: Tax Credits
Tax credits are legislative enactments that allow a taxpayer to reduce the amount of tax they owe. After a taxpayer’s tax liability is calculated, a taxpayer may then directly reduce their liability by tax credit amounts they are eligible for.
Take a taxpayer who has one child and is eligible for the Child Tax Credit. The taxpayer’s taxable income is $50,000, and the taxpayer’s tax liability is $4,500. The Child Tax Credit (worth $1,600) directly reduces the tax liability from $4,500 to $2,900. The Child Tax Credit is not applied to the $50,000 of taxable income; instead, it is directly applied to the tax liability amount.
The largest tax credits are all associated with legislative incentives for specific types of taxpayers. For example, the Earned Income Tax Credit awards tax credits to those of low income, while the American Opportunity Tax Credit and Lifetime Learning Credit award those pursuing higher education. The Child and Dependent Care Credit benefits those with children/dependents.
Refundable vs. Nonrefundable Tax Credits
Some federal tax credits are nonrefundable, meaning once they reduce your tax liability to $0, a taxpayer may not receive additional benefit nor receive a refund due to an unused portion of the credit. An example of a nonrefundable tax credit is the Adoption Tax Credit. Once the credit reduces a taxpayer's tax liability to $0, the taxpayer will owe no tax.
On the other hand, some credits may be refundable. In that case, not only can the tax credits reduce a taxpayer's liability to $0, but they may result in the taxpayer receiving a tax refund.
For example, if you owe $750 in taxes but qualify for a $1,000 refundable tax credit, you would ultimately receive a $250 tax refund. That is, $750 of the tax credit would eliminate your $750 tax bill and the remaining $250 of the tax credit would become your refund.
Be mindful that some credits are partially refundable. For example, for tax year 2023, the Child Tax Credit of $1,600 was partially refundable; for 2024, up to $1,700 is refundable.
State Income Tax vs. Federal Income Tax
It is important to distinguish between the definition of income tax and federal income tax. In the U.S., governments at the state level may also levy income taxes. These are in addition to federal income taxes.
Not all states have state-level income taxes. As of 2023, Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, and Wyomingdon’t have an income tax.
New Hampshire taxes dividends and interest income only, but the state will completely phase out these taxes by 2027.
Individual vs. Other Federal Income Taxes
The information above relates primarily to federal income taxes for individuals. The IRS also collects tax revenue from other entities.
Business Taxes
Businesses must report income and can receive tax benefits similar to individuals. Certain legal business formations, such as partnerships, have a different tax filing date compared to individual filers. In addition, businesses are subject to a wide range of tax credits only available to businesses. Many credits derive from the General Business Credit, and are figured using Form 3800.
Nonprofits
Charities and nonprofits that have received tax-exempt status usually must file Form 990 with the IRS to maintain their tax-free status. This information return does not result in any taxes owed by the nonprofit. However, information provided on the return may result in further evaluation or revocation of the tax-advantaged status.
Foreign Businesses and Individuals
Last, international individuals or businesses may be required to file federal taxes. There are specific rules for foreign entities with income-generating activities within the U.S. and domestic entities with income-generating activities outside the U.S.
What Are the Federal Income Tax Brackets for 2023 and 2024?
For the 2023 and 2024 tax years, the tax brackets are 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
Does Social Security Count As Income?
Social Security benefits are not counted as gross income. However, benefits are included in your combined income, which the IRS uses to determine if you should pay taxes on your benefits. Combined income is determined by totaling your adjusted gross income (AGI), nontaxable interest, and half of your Social Security benefits. If your combined income is between $25,000 and $34,000, you may be taxed on up to 50% of your benefits. If your combined income is more than $34,000, you may be taxed on up to 85% of your benefits.
Which Country Has the Highest Federal Income Tax?
Ivory Coast has the highest tax rate at 60%. Finland (57.3%), Denmark (55.9%), Japan (55.95%), Austria (55%), Sweden (52%), Aruba (52%), Belgium (50%), Israel (50%), and the Netherlands (49.5%) round out the top 10 as of 2023.
Which U.S. President Imposed the First Federal Income Tax?
President Abraham Lincoln was the president to impose the first federal income tax by signing the Revenue Act on Aug. 5, 1861. The reason he did so was to finance the Civil War. A 3% tax was imposed on all annual incomes over $800.
When Is Federal Income Tax Due?
Generally, federal income tax is due on April 15 of every year. The day can shift slightly if April 15 falls on a weekend or because of other factors.
The Bottom Line
Federal income taxes are considered a marginal tax or progressive tax and apply to all forms of earnings that make up a taxpayer's taxable income, including wages, salaries, commissions, bonuses, tips, investment income, and certain types of unearned income.
Each year, the IRS releases updates to the tax brackets and rates that apply to single filers, married individuals filing joint returns or separately, and heads of households.
