Bumping into a Higher Tax Bracket – Know how to Avert This Sudden Hike

Bumping into a Higher Tax Bracket – Know how to Avert This Sudden Hike

Which tax bracket are you in and what does that actually signify? Well, your tax bracket is the rate of income tax which you pay on the highest dollar that you earn out of your taxable income. Tax bracket doesn’t mean the tax rate which you pay on your entire income post deductions, adjustments and exemptions. It just decides the amount at which your income tax multiplies when you earn even a single extra dollar of income.

In the US, there are tax brackets as they are into a progressive system of income tax. This clearly implies that you have to pay more tax for more money that you make and hence your income tax bracket will also become higher. If you don’t know what progressive income tax is, then they’re based on the concept that taxpayers who earn higher income can bear the burden of a bigger tax rate. On the other hand, the lower income taxpayers not only pay low taxes altogether but even a lower percentage of income that they make.

2016 Tax Brackets – A quick glance at the table

10%$0 – $9,275$0 – $18,550$0 – $13,250
15%$9,275 – $37,650$18,550 – $75,300$13,250 – $50,400
25%$37,650 – $91,150$75,300 – $1,51,900$50,400 – $1,30,150
28%$91,150 – $1,90,150$1,51,900 – $2,31,450$1,30,150 – $2,10,800
33%$1,90,150 – $4,13,350$2,31,450 – $4,13,350$2,10,800 – $4,13,350
35%$4,13,350 – $4,15,050$4,13,350 – $4,66,950$4,13,350 – $4,41,000
39.6%$4,15,050 and above$4,66,950 and above$4,41,000 and above

How does the tax bracket work?

Suppose you’re single without any dependent and the income on which taxes are applicable is $9000. As per the Federal Income Tax bracket chart given above, your marginal rate of tax is 10% and hence you pay $900 to Uncle Sam. This is indeed a simple calculation.

Now what would be your tax rate if your income is $19,000?

Being a single filer, you fall into the next bracket of 15% but hey, that won’t mean you have to pay 15% on the entire income ($19,000). Rather you pay 10% on the first $9,275 and 15% of the amount which is over $9,275. Here’s what it would look like:

First tax bracket: $9,275 X 10% = $927.50

Second tax bracket: ($19,000 – $9,275) X 15% = $1,458.75

Total Income Tax: $2,386.25

You can therefore find out your income tax rate and the bracket you fall into by checking out the income tax chart given above.

Avoid bumping into a higher income tax bracket – Few ways to consider

Although you shouldn’t be scary about bumping into a higher income tax bracket but what’s the harm in knowing how you can avoid taking a sudden leap? Here are few ways to avert spiking into the next tax bracket.

#1: Make sure you lend money towards retirement plans

When you put money towards your workplace retirement funds like 401(k), IRA and other sorts of retirement accounts, this certainly diminishes your taxable income. If you’re at the risk of leaping into the next higher income tax bracket, increase your contributions to retirement funds. Nevertheless, when you withdraw money from this account, be sure to pay taxes. In case you’re in a low tax bracket post retirement, you will have to pay for reduced income taxes in that way.

#2: Don’t take the risk of selling too many financial assets in a single year

Suppose you’ve got a stock which has suddenly went up in value within a very short span of time. You would definitely want to sell it off and earn cash in return. But as a financial strategy it is better to sell a few shares in this year and the remaining a year later as selling all the stocks together would definitely push you to the next income tax bracket. And in case you’ve held on some other capital asset like stock, you can even qualify for capital gains for a long term and that would even be lower.

#3: Carefully plan the time of business expenditures and income

If you’re a business owner or you’re self-employed, you can exercise control on the timing of receiving payments from customers and when you need to make expenses. While utilizing the cash process of accounting, you are supposed to claim revenue in the same year you obtain it even though you worked in the last year. If you’ve seen a good year or you require business equipments, you could buy it during the end of the year. At the same time, if you have seen a bad year altogether and you wish to be in the next income tax bracket, you may stop making commercial expenses until 1st January.

#4: Leverage ‘income averaging’ if you’re a fisherman or a farmer

There are some taxpayers who are given the discretion of smoothing their income over a period of 3 years by leveraging a method called ‘income averaging’. This helps them by keeping income spikes from shoving them into higher tax brackets. Before 1987, every taxpayer could utilize income averaging but now you have to be either a farmer or a fisherman in order to reap its benefit. But what would happen if you fail to avoid pushing yourself into the next tax bracket with a rise in income? Everything else being the same, you will definitely make more money and what’s the harm in paying a bit more to Uncle Sam?

If you make enough money to enter a higher tax bracket, you could take home less amount of money as compared to when you stayed in a lower tax bracket. This is somewhat a myth which is believed by most taxpayers. Most Americans fail to comprehend taxes in the right way and it is pretty acceptable as the American tax code is mysterious and perplexing. However, after going through the above mentioned information on tax brackets, you should be able to believe in the truth and take action accordingly.

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