Updated on Dec. 28, 2017: We’re in a rare position right now: A massive tax reform bill has been signed into law just as tax season begins. That means Americans have a lot of questions about taxes: How will this overhaul affect me? When will it affect me? And what tax bracket am I in???
The first question is complicated, given the GOP tax bill has a lot of moving parts. But we're happy to help right now with the second two. Most provisions of the tax bill President Donald Trump signed into law Dec. 22 take effect on Jan. 1, 2018. However, the law isn't retroactive, so when you file your 2017 taxes in 2018, you're subject to the old tax brackets. The new tax brackets won't come into play until you file your 2018 taxes in 2019. We get this is confusing, but the chart below illustrates the tax brackets pre- and post-GOP reform.
We get this is all really confusing, so if you're trying to figure out what to do this year, we put together a guide to filing taxes in 2018.
How tax brackets work
Of course, figuring out your tax bracket is a little more complicated than matching up your net income with the percentage you're supposed to pay to Uncle Sam. For tax brackets to make sense, you have to know a little about how the U.S. tax system works.
In America, we have a progressive tax system. Basically, if you make more money, you pay a higher percentage back to the government. This system is different than, say, a flat tax system, where everyone pays (for example) 10% back to the government. In a flat tax system, people who make more still pay more, because 10% of $100,000 is more than 10% of $20,000, but the percentage is the same.
A progressive tax is different. Your taxable income is divided into different income levels – the tax brackets as outlined above – and levied at different rates. But only the amount of income that falls into a particular tax bracket is taxed at that marginal rate. So, for instance, in tax year 2017, anything below $9,325 is taxed at 10%, but anything between $9,326 and $37,950 is taxed at 15%, income between $37,951 and $91,900 is taxed at 25%, and so on.
That progressive system still applies in tax year 2018, but the numbers, of course, change: Anything below $9,525 gets taxed at 10%, but anything between $9,526 and $38,700 gets taxed at 15% and so on.
As you may have gleaned from the chart, your tax bracket changes depending on how you choose to file:
- Single, which you’d choose if you’re single (pretty self-explanatory)
- Married filing jointly, if you and your spouse are filing together
- Married filing separately, if you and your spouse are filing individual returns
- Head of household, which you can claim if you’re unmarried but paying for more than half of household costs and have a dependent.
How tax brackets affect your taxes
Still confused about how tax brackets work? We hear you, so here's an example to help clear things up. Let’s say you made $65,000 in 2017. That puts your tax rate at 25%, so you’ll pay $16,250 in taxes, right?
Not quite – because remember, the tax rates are marginal. You’re in the 25% tax bracket, but that’s not how much you’ll pay – it’s how much you’ll pay for the highest portion of your income.
Instead, you need to calculate the tax rate for the different levels of taxable income. Using the table above, you’ll see that your first $9,325 is taxed at a marginal rate of 10%, so you pay $932.50 on that amount.
The next tax bracket cuts off at $37,950; you’ll pay 15% on $28,625 ($37,950 minus the $9,325 that falls into the previous bracket), or $4,293.75.
Your $65,000 income then bumps you up to the 25% tax bracket, so $65,000 minus the previous $37,950, taxed at a rate of 25%, is $6,762.50.
Add all of those taxes up – $932.50 + $4,293.75 + $6,762.50 – leaves your total tax bill at $11,988.75.
If you take that as a percentage of your total taxable income, you’ll see that, even though you’re in the 25% tax bracket, you’re only paying 18.44% (and saving nearly $4,000 in the process).
Lowering your tax bill
It’s important to have an idea of what tax bracket(s) you fall into so you know how your income is affected. If you’re making $37,000 and take on a side gig that gets you another $2,000, that bumps you up into the next tax bracket.
Keep in mind that you’ll only pay the increased marginal rate on the income amount that falls into the higher tax bracket, but you still won’t be netting that full $2,000 so you’ll have to decide if that side gig is worth your time.
Of course, it also works the other way: Reduce your taxable income and you might drop into a lower bracket.
There are a few ways to lower how much income you’ll get taxed on. You can claim deductions, like business expenses or mortgage interest payments. You can make donations to charity or contribute to retirement accounts, like traditional 401(k)s or IRAs, that take out money from your paycheck pre-tax so you only get taxed on the amount that’s leftover.
You’ll probably only drop to a lower tax bracket if you’re right on the edge of one (or if you donate a lot to charity), but no matter what, every dollar that you don’t pay in tax means a little more money in your pocket at the end of the year.
Looking ahead to 2019
The GOP tax bill makes big changes to deductions. Most notably, it imposes new caps on mortgage interest deductions (for home loans taken out on or after Dec. 15, 2017). It also limits state and local tax deductions to up to $10,000. There was no cap before, which is why people are rushing to pre-pay property taxes this year.
On the flip side, the bill raises the standard deductions to $12,000 for individuals, $18,000 for heads of household and $24,000 for married couples filing jointly. So, it's probably a good idea to consult a tax professional to see what your best bet is when it comes to filing taxes next year.