By Dr. Jim Dahle, WCI Founder
Understanding how your income is taxed and how the tax brackets work will aid your tax planning and make for more informed, reasonable discussions of tax policy. Now with 2024 right around the corner and with inflation (perhaps) being tamed (at least somewhat), let's take a look at the new tax brackets and see how best you can plan for the new year.
Here's what to know as 2023 fades away and a new year begins.
Tax Brackets for 2024
For context, here were the tax brackets for 2023, via the IRS: Keep in mind that, thanks to inflation, the increase from 2022 to 2023 was huge.
Here's how the tax brackets will change for 2024.
The standard deduction has also been raised for 2024. Here's what it was in 2022.
Here's what it was for 2023.
And here's what it'll be for 2024.
So, from 2022 to 2023, there was a big increase, thanks to inflation. For 2024, though, the increase is more modest, similar to how much the 2024 retirement contribution limits increased.
People Don't Understand How Tax Brackets Work
One of the most interesting phenomena I've noticed over the years is that most people don't actually understand how tax brackets work, and they routinely overestimate how much they pay in taxes. For example, I put up a few Twitter polls a couple of years ago discussing tax brackets. Take a look:
Keep in mind, these are not opinion questions.
These questions actually have correct answers that can be easily calculated and, frankly, given how far apart the answers are from each other, pretty easily estimated. It's like asking “Is China closer to Vietnam, Switzerland, Cuba, or Tonga?” Yet only 27%-30% of people got the answers right. Sheer random chance would allow 25% of them to get it right. But what is more interesting is that 61%-73% of respondents OVERestimated the tax burden.
More information here:
You Should Do Your Own Taxes at Least Once – Here’s How I Do Mine
How Do Student Loans Impact Your Taxes?
Why People Don't Get Tax Brackets
There are a few reasons why people can't answer those questions right. I think I know why.
#1 People Don't Understand the Difference Between Marginal Tax Rates and Effective Tax Rates
Remember that your marginal tax rate, or tax bracket, is the rate at which your next dollar earned will be taxed. Your effective tax rate is the total tax paid divided by your total income. Your effective tax rate is always less than your marginal tax rate. Perhaps this is best illustrated by demonstrating how to come up with the right answer to the question.
If a married couple earns $100,000 in 2024 and takes no deductions besides the standard deduction, how much will they pay in federal income tax?
First, they subtract out the standard deduction of $29,200. That leaves $70,800. The first $23,200 is taxed at 10%, generating $2,320 in tax. That leaves $70,800 – $23,200 = $47,600. That $47,600 all falls within the 12% tax bracket, and so it is all taxed at 12%. $47,600 x 12% = $5,712. $2,320 + $5,712 = $8,032. $8,032/$100,000 = 8.03%. The numbers were different in 2022 and 2023 when we did these examples (8.5% in 2022, 8.23% in 2023, and now 8.03% for 2024 with owed taxes of $8,481 in 2022, $8,236 in 2023, and now $8,032 in 2024), because of the new tax bracket limits. But you get my point.
There are two key points here. The first is that there is a 0% bracket. Some of your income is not taxed at all. That might be the standard deduction. It might be itemized deductions. There might be some above-the-line deductions. Whatever. But anything you get a deduction for isn't taxed at all. It's in the “0% bracket.” Some critics on Twitter started listing all these other deductions that could be taken. However, all of those would have LOWERED the tax due. This is, in essence, the MAXIMUM tax paid on that income, not the minimum. So, most people still overestimated the tax due, even though I used the maximum tax possible in this situation.
The second is simply that being in the 12% bracket does not mean you pay 12% in taxes. You only pay taxes on the money in that bracket. You fill the brackets as you go. Otherwise, you would have paid $12,000 in taxes instead of $8,032. If you knew someone making $100,000 was in the 12% bracket, you should know that the answer to the question MUST be less than 12%. There is no reason whatsoever to guess a number higher than that.
#2 People Don't Understand the Difference Between Taxes Withheld and Taxes Paid
Most people are employees. They don't actually calculate how much tax they owe, and they don't send it to the IRS each quarter like business owners do. It is just pulled out of their paycheck by their employer before they get it. The newer withholding tables are more accurate than the older ones, but most employees still have more withheld than they actually owe. That's why they get these huge tax refunds every spring. That is another phenomenon I find interesting—just how bizarrely happy people are to loan money interest-free to their government. But I think it contributes to the idea that people think they pay a lot more in taxes than they do.
#3 People Don't Know What Federal Income Tax Is
There are also a lot of people who don't know the difference between all of the taxes we pay. Don't get me wrong: there are a lot of taxes. There are state and local income taxes. There are payroll taxes like Social Security tax, Medicare tax, one of the two types of Patient Protection and Affordable Care Act (PPACA) taxes, and unemployment tax. There are sales taxes and property taxes and gas taxes and inheritance taxes and estate taxes. I guess it should be no surprise that people cannot tell them apart. Several of these are also withheld from their paychecks (the state and local income taxes and payroll taxes like Social Security taxes, Medicare taxes, and one of the two PPACA taxes). In fact, some of those payroll taxes (and the other PPACA tax) even show up on their federal income tax return, further confusing the situation.
Most people DO pay significantly more than 8.03% of a $100,000 income in taxes but not in federal income taxes. The federal income tax is quite progressive (44% of people pay no federal income tax at all while others have marginal tax rates as high as 37%). However, there are other taxes that are not progressive. My state income tax in Utah is a flat tax, at least once you get past the deductions. Medicare tax is a flat tax—2.9% on all wage income, half from the employer and half from the employee. Social Security tax is also flat—12.4% on all wage income, half from the employer and half from the employee (but only up to an income of $160,200 in 2023 and $168,600 in 2024). After that, it goes to 0% (at least for the employee), thus becoming a regressive tax at upper incomes.
At any rate, people may not realize that the federal tax brackets only apply to federal income tax.
#4 People Think Everything Taken Out of Their Paycheck Is Tax
Even worse, some people just assume everything taken out of their paycheck before they get it is a tax. Including their retirement account contributions, their share of any life or health insurance premiums, or even court-ordered child support. Sorry, some of those are good things to pay, but they're not taxes, much less federal income taxes.
I think it is important to understand how our taxes, especially the largest one for most of us—the federal income tax—work. Knowing how they work will help you to better manage your own finances and to actually have intelligent discussions with others about government and tax policies.
What do you think? Why do you suppose most people couldn't answer the questions above correctly? Why is the tax code so mysterious to US citizens? Comment below!
[This updated post was originally published in 2020.]
What about the standard deduction for those of us over 65?
It’s a little higher: https://www.kiplinger.com/taxes/tax-deductions/601640/standard-deduction#:~:text=For%202021%2C%20taxpayers%20who%20are,is%20both%2065%20and%20blind.
The biggest issue is that 0% bracket of the standard deduction is not shown. we see only the 10, 12, 22%, etc values. So doing quick estimates points to values near 11% for 100k example. It is a definition problem. You have to define 0% as 0 to $25000, $25001 to 34950, etc. Then it is obvious to the average person that $25000 is not taxed. So the effective tax bracket shrinks. No one will update the chart because standard vs itemized deductions, but the current chart does not explicitly show the non taxed money which explains why people generally overestimate their tax rate.
Aside from the below the line deductions (itemized vs standard) the above the line deductions like 401k contributions etc are also huge.
My personal belief is the United States tax system is too complicated. I disagree with all the convoluted itemized deductions. If the IRS already knows what you owe them, shouldn’t they just send the bill come tax day and be done with it? The reason that does not happen is thanks to the lobby of the tax services here in America.
While I do not agree with the amount of financial literacy required to do well in America, it’s more like if you can’t beat ’em join ’em. The reason most people don’t know how to answer various tax related questions on your Twitter survey is because they use the software systems to enter amounts in an almost infantilized platform. I think there’s a reason TurboTax doesn’t allow you to enter values directly in the various forms – it is a positive feedback loop to driving greater tax financial illiteracy.
I am no tax whiz and have been guilty of using the software in the past with no real understanding of how the calculations were done. That was when I had a lot less time. Now that I am older and with a bit more time to dedicate to my financial literacy, I have suffered through figuring out how marginal tax rates and effective tax rates work. Quite frankly to me ISOs come with some of the most complicated tax implications that affect your decision of if and when to pull the trigger. To me, everything other than ISOs is now well within my understanding. I have yet to own real estate, so I’m not entirely comfortable with real estate taxes yet. That’s a mountain waiting for me.
Long and short of this long winded comment is that I’d recommend filing with a software but also figuring out some of the basic calculations by hand so that you know how the whole system works. If you don’t know, you might overpay. The IRS always accepts tips 😉
My mind boggles at some of the questions you got. My take is: If you are single and make more than about 35k and live in a state with income taxes OR if you are married with or without kids then spend a few bucks on TurboTax or H&R Block tax software for the following reasons:
The interview method they follow is pretty straightforward. It is both a way to get your return done and a way to learn what matters and what doesn’t.
You can and should use your tax software to estimate next years tax due by creating a dummy return with estimated numbers.
Pay attention to this article. Your effective tax rate and where the next income threshold is are what matter most when planning.
If your income changes a great deal up or down, think seriously about working with a CPA for a year or two. It is worth the peace of mind.
I have been doing my own taxes for 50 years. I am not an accountant. I just read the rules an now that we have the internet use http://www.irs.gov for research.
Keep in the back of your mind that the tax prep companies want to scare you into believing you can’t file your own taxes. You can. You might decide it is more cost effective to offload the arithmetic to someone else but you still have to do the scut work of keeping records all year.
Is anybody else still confused? I’ve read this twice and it does not compute.
The main point to get is that if you get bumped into the next bracket, you only pay taxes at that rate on the money made in that bracket, not on everything you earn. Do you understand that?
Hello
Hi.
Hello.
I make about $570k and my CPA churned out a 23% effective tax rate with deductions (live in NYC). Is that considered good or should I find a new CPA?
I don’t think you understand how taxes work if you think the CPA is somehow responsible for your tax rate. It’s far more about how you live your financial life. It might be very good for a single person and very bad for a married person for instance. All I want out of a CPA is accuracy, good service, and answers to my questions. I don’t hold them responsible for my effective tax rate.
You are absolutely right. What I meant to ask as a married filing jointly, is an effective rate of 23% decent? Where does that fall on the bell curve for the salary, location, and filing jointly? And if o understand everyone is different with different deductions but I wanted to know ball park. Thank you again.
It’s less than I’m paying in Utah so I’d say you’re doing fine.
Jim I’m sure you get this a lot but you deserve some sort of medal for your patience.
Thanks for your kind words. We all have to learn this stuff once so I try to remember what it was like when I was first learning it.
The $8,590 tax bill for the $100K couple did not include child tax credits, did it? If not, then the taxes would be even less than 8.6%.
You’re right that additional credits or deductions would further lower the bill. No kids were mentioned in that tweet, so there was no child tax credit included in the tweet.
Professionals understand ‘complexity well’. Just like you need to be a doctor to understand the intricacies of various elements, just the same way IRS puts out tax laws in a manner that is only understood by the tax professionals completely. For the rest of the public it is partially understood/misunderstood, interpreted/misinterpreted and also highly debated. It is never the intention of WebMD to make an average consumer a doctor-like-person (and yet many play so), and in the same way, try to read a very deep chapter like International Tax obligation doc at the IRS site, and it will be clear that one needs to be a lawyer and accountant to get it.
For example, I have asked 4 Tax Accountants on how to account for Fiscal Tax Years vs Calendar Tax Years when reporting International Income and Tax Payments to another country, and I have gotten 3 different answers on it. Why? If you read the description it is hard to understand.
Sure they could have taken Marginal Tax Rates, Effective Tax Rates, Standard and Detailed Deductions and made it simpler, but no, they had to make it a ‘science and art combined’ and leave it to interpretations.
Hence, even though I have Tax Accounting Services, I buy Audit insurance on the top of it to cover the basis, and get me represented in case my return is questioned/audited. Audi Insurance is “cheap” and they do a lot of things.
Good article and need more like these…..
Ken
The frustrating thing is when you hire a professional and they screw it up too. I had my personal taxes done by a professional this year for the first time ever. Guess what they messed up? That’s right, the Backdoor Roth IRA. Twice. The first time I showed them how to do it. Then I pointed out that they had misdone it with the review copy they sent me. Then they still screwed it up on the final return they submitted. They did refund part of the fee (which was already 3X what I had expected, but my expectations were probably way off.) At any rate, here it is December 28th, 2021 and my 2020 taxes are still not complete (corrected state returns). And now I’ve got to decide whether to keep the same person, find someone new, or go back to doing it myself.
I’m very aware how the tax brackets work, but I like to add all mine up: federal, state, local, Social Security, Medicare, Medicare surtax, and self employment tax on my side gig…and then say (to myself), I pay about $XXX,XXX in TOTAL taxes. When I think of taxes, I think of them all. Heck, I even add in property tax on the main house and the soon to be retirement home. I do pay attention to my federal effective tax rate and it has been about 20% for years.
I saw a lot of posts implying that at some point, marginal income is so highly taxed that it’s hardly worth making. I’m fond of saying “I can’t wait to make less money so I can pay less in taxes”, but it’s really “I can’t wait to finish stoking the kids college accounts and maximizing my retirement accounts so that I am able to retire to a much smaller tax and expense foot print.” In semi-retirement, its even more important to know tax law and only pay what is legally due.
My income at present is almost halved by taxes (federal, state, local, Social Security, Medicare, Medicare surtax, and self employment tax), maxing out retirement accounts (paying myself really), and college funding. When I drop to one day a week in 2022 after 28 post residency years of Psychiatry, my “total of all” taxes drops by an amazing amount. I’ll be in a much lower marginal bracket (drops from 32% to 22%).
Since I will only have a Solo 401K at that time and much lower income, my retirement contributions also drop by about 80%. The kids college accounts are fully funded. It sounds like I will have a much lower standard of living, but because my tax bill drops markedly as does my retirement account stoking and kid’s educational expenses, I think we will be fine. That half of our income is no longer needed. The sale of our big house at this time of higher prices is fortuitous.
I’m sure I’ll be more of a tax expert in semi-retirement, partly motivated by freedom that I can lose if we spend too much. I have an accountant and may still need him for a while in the transition, but I am looking forward to having such a simple tax situation that I can use the standard deduction and Turbo Tax again. So, I am looking forward to making less money and getting into the lower bracket, which sounds a bit strange. It’s a choice to live a less expensive life. I simply don’t need much of anything anymore and hiking is mostly free. If it works, I will have bought my freedom.
Don’t forget sales tax!
Yes, tax is our largest expense. Maybe one of these days we can get our charitable contributions up above our taxes. Haven’t hit that mark since I was in the military. Those progressive brackets can really add up quickly.
I too think of my total taxes in dollars paid and only incidentally in terms of effective tax rate. I look at total taxes as a percent of total income. Taxes are by far my largest expense.
Looking at taxes as a percent of income, I take a special approach to consumption taxes. I figure I can avoid them by consuming less. Sales taxes are hard to total, since I don’t track how much I spend on taxable or nontaxable purchases. Buy a cheaper house and cut my real estate taxes. That part is easy. I calculate taxes as a percent of income with and without consumption taxes.
It still surprises me that people don’t know the dollar amount they pay in income taxes. Don’t they look at the tax returns they file?
Which version of Turbo Tax should I get:
1) My husband has all 1099 income (he does solo 401k)
2) I have mainly W2 and some 1099 income ( I do backdoor Roth, and hope to do solo 401K for 2021)
3) WE have 2 rental properties
4) I have a child in pre-school
5) I also get a K1
Beats me, but the nice thing about Turbotax is that if you need something more expensive, they’ll prompt you to buy it later.
I suspect Home and Business is the right answer and I’d probably just buy that. Good luck with the rental properties; that’ll be the trickiest part. The Schedule Cs for your husband’s business (and your business) will probably be easy, the K-1 is no big deal, and the preschool thing is a nothingburger.
Great post on how tax brackets work with the calculations to illustrate things!
Governments buying companies for free over 3.1 – 3.9 year’s.
Government collect business sale tax U.S 40% AU 30% tax.
Shareholders pay 50% U..S & AU with long-term shareholders. Depending how many shares the owner realises. U.S 37% AU 25% – 30% business sale tax.
America goes half of GFC debt “say” $10 trillion dollars. They get back 45%+ in taxes & company profits pa are $650b company makes profit of $100b. $10 trillion dollars worth of companies brings in profit of around $1.7 trillion dollars.
After around say 3.7 year’s we start to make money because after 3.7 year’s time with collected business sale & shareholders paying taxes, we clear $1.7 trillion dollars extra in budget.
Circulation currency is easy. Go into debt your economy size AU$3 trillion dollars & you hand out to 75% of the public poor, low income earners, middle class & rich but not over $2.5 million in assets. Now hand small business owners $200,000 dollars pa & the rest of the public $75,000 each pa. The catch? Seen as all small business owners get $200,000 dollars tax free clear topped up pa, small business pay’s a 60% tax per item “so” sales tax. 2 taxes are collected from sales tax. Big business pay 40% to big business to big business. Big business pay’s 30% tax to sell to small business. Small business pay 60% tax. 20% GST tax.
Big business to big business 40% + 40% + 20% = 100% back of circulated $.
Big business to small business 30% + 60% + 20% = 110% of dollar back “or” $1.10c made back per $1 spent. Their sacrificing the original economy size income in new taxes, why the circulated currency stays in the country.
Small business to small business 60% + 60% + 20% = $1.40c = 140% back per dollar spent.
Now you can payback debt and loss of currency is coved by 15% as well as debt being paid back.
Ligit
Looks like a minor typo/truncated sentence here:
“ (but only up to an income of $147,000 in 2022 and $160,200).”
Perhaps should be:
“ (but only up to an income of $147,000 in 2022 and $160,200 in 2023).”
?
Good catch! It’s been fixed.
One good way to learn the tax code is by doing your own taxes. I started out in the pre-computer days and have continued w/ a tax program. I don’t recommend going to back to those early days. but I’d recommend it to those so inspired. I guess I’m one the weird ones, but I like doing taxes. To me, it’s like playing a computer game w/ real money on the line. And it eliminates one reason for IRS problems: math errors, and allows you to spend time on the big issues.
If I never made math errors… one year (complicated by dual country income) I calculated 3 different numbers and decided to pick the middle figure as my tax due. No audit or even correction via mail which I have gotten every three years lately- maybe since they couldn’t tell either.
Latest silly internet meme I had to share here (obv from Liberal website): ‘I told my 5th grader that AOC wants to take $7 of every $10s I earn and she said “That’s not how tax brackets work. And you’ll never make enough money to need to understand them anyway.” ‘
Hi,
I started as an independent contractor under sole propritership. In Q4 2021 I formed an S-Corp. So 2021 incone was split between my sole proprietorship and Scorp (my LLC) and hence I designated business expecses accordingly. I have a couple of questions:
1. For 2022 tax year, should all expecses be reported under S corp (form 1120-S) and nothing on my sole proprietorship? please note I haven’t dissolved my EIN of Sole proprietorship. Or can I still split expenses between the two?
2. Is it ok to show expenses even when there isnt any revenue generated from the business?
Thank you
1. Yes. Why would you keep both?
2. Yes, a business can take a loss for 2 out of 5 years without having to worry about being reclassified as a hobby.
Thank you for your promt reply. I do have a business account but I was not organized enough to put all qualifying expenses on it diligently. I have used my personal bank account for some of the business related expenses. That’s part of the reason why I wanted to post expenses separately under the S copr and under Sole proprietorship.
Do you suggest, I report all expenses under S copr regardless of whether they were put on the business account or personal account?
Thank you
Well stop mixing personal and business assets whether you are a sole proprietorship or an S Corp. That’s # 1.
Have your S Corp formally reimburse you for your personal expenses. Treat it as a completely separate entity.
Thank you so much! This was a super helpful post and I finally (at age 41) went through this calculation. Having done calculus and other complicated mathematics, I always wondered why I get confused with taxes. I think it maybe that I never bothered to fully understand it, was blaming confusing lingo and all that before but now I know where the blame lies on =)
Appreciate all you do!
I have a question about tax obligation for long term capital gains when filing as married jointly.
Are these brackets marginal? Or all or none?
For example, if a couple earns $200,000 in taxable income after deductions and that income is entirely from long term capital gains, is the entirety of the $200,000 taxed at 15%? Or is the initial $94,050 taxed at 0% (for 2024) and the remainder, $105,950, taxed at 15%?
Thanks
On the same line of thought WCI, I was confused by marginal tax rate effects of dividends and capital gains, since of course the tax form or worksheet (QDCGTW Qualified Dividends and Capital Gain Tax Worksheet) goes through enough steps to ensure it isn’t clear cut- keeping accountants and tax software in business! Like the tax on social security income: at least most of us on WCI can say “85% of social security is going to be taxed” when we start drawing, but helping my older relatives I still wade through this to be certain at their income levels.
However for me (working the QDCGTW out to avoid a bump in my marginal rate on Roth conversions) I found that our regular, nonqualified taxable income has a marginal tax rate is NOT affected by QDCG which will have the 15% rate. Some WCIers make enough that they might jump to 20% QDCG tax rate with an increase in regular income but I didn’t bother to prove that to myself. Can you have some math/ tax guru write a post trying to explain this in words I can use with my kids and MIL, and that would better illustrate this to Siahus re his Dec 2020 and this week’s JR’s comment? Thanks.
On the same line of thought WCI, I was confused by marginal tax rate effects of dividends and capital gains, since of course the tax form or worksheet (QDCGTW Qualified Dividends and Capital Gain Tax Worksheet) goes through enough steps to ensure it isn’t clear cut- keeping accountants and tax software in business! Like the tax on social security income: at least most of us on WCI can say “85% of social security is going to be taxed” when we start drawing, but helping my older relatives I still wade through this to be certain at their income levels.
However for me (working the QDCGTW out to avoid a bump in my marginal rate on Roth conversions) I found that our regular, nonqualified taxable income has a marginal tax rate which is NOT affected by QDCG which will have the 15% rate. Some WCIers make enough that they might jump to 20% QDCG tax rate with an increase in regular income but I didn’t bother to prove that to myself. Can you have some math/ tax guru write a post trying to explain this in words I can use with my kids and MIL, and that would better illustrate this to Siahus re his Dec 2020 and this week’s JR’s comment? Thanks.
Dividends and capital gains stack on top. If you just remember that, you’ll make the right decisions.
I wrote a post about it a while back, but maybe it hasn’t yet been published. Here’s the conclusion from it:
Perfect! If you published that blog already I must have missed it because I probably would have printed it out to staple to the printed out QDCGTW page which to add insult to injury isn’t included in the fill in forms from the IRS. Just because we don’t mail it to them doesn’t mean they couldn’t keep me from having to print it out and use pen or pencil, or recreate the form on my spreadsheet. (And I can never find where I put it on the spreadsheet since it’s way down or way to the right of the 1040 figures.)
Marginal.
Appreciate the clarification – Thanks for your efforts on this topic.
Unfortunately the social security (and thus my military pension) wasn’t so generous. The brackets went up by 5.4%, but the social security and military pensions are going up 3.1%.
The IRS uses the chain weighted CPI (changed from CPI by Trump Tax Cuts). It takes into account consumer spending trends by capturing both general changes in spending, as consumer preferences change, and substitution effects, when relative prices change.
The social security bump is based on changes in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), an inflation measure tracked by the U.S. Department of Labor. The SSA compares the CPI-W for July, August and September of one year to the same period the year before.