Here are tax brackets in 2020.
Simple, right? But many of us make a common mistake when looking at this. Let’s say my income is $85,000. You might consider that puts me in the third bracket. So I would owe the IRS 22% of my income.
This is wrong. And it’s making us have uninformed debates about taxation policy. Here’s how it actually works.
Let’s go back to my $85,000 income. Now, instead of thinking of tax rates as brackets, we should think of them as pockets. But firstly there’s one special pocket we need to talk about. The money we put in this pocket is not taxed. The government automatically let single people have $12,400 in this special pocket — $24,800 for couples and $18,650 for Head of Households.
But if you spend a great deal of money on things like medical outlays or charitable gifts, you can sometimes put in more. These are called deductions. With the $72,800 ($85,000-$12,200) that’s leftover we can start filling up the pockets. The first pocket has room for $9,875, so I merely compensate 10% on this money. Then I compensate 12% on the money in the next pocket. And then 22% on the money in the third pocket. These are called marginal tax rates. And that’s how these brackets actually work.
So if I get a raise, that new money goes into the third pocket with empty space. When opening runs out, we place the rest in the next pocket. So the raise would be partially taxed at 22%. And partially at 24%.