Taxes 2020: What you don’t know about your tax bracket could hurt you
Tax brackets may be one of the most misunderstood aspects of the tax system — and that can hurt taxpayers.
“In the past three days, I've had two people say to me, 'I have a dumb question: Is it true if I'm right against the tax bracket, and I make $100 more and get bumped into the next tax bracket I’ll pay thousands of dollars extra in taxes?'" says Chris Mulvaney, a tax director at CBIZ MHM. “There is this misperception that all your income will be taxed in the top bracket.”
As that question suggests, many people believe that their top marginal rate reflects the percentage they’ll pay on their entire income. In other words, a single taxpayer with $100,000 in annual income might mistakenly believe that her top marginal rate of 24% applies to every dollar she earns.
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But that’s not how tax brackets work. Instead, she’ll pay 10% on her first $9,700 of income, then 12% on income over $9,700; 22% on income above $39,470; and 24% on the portion of her income above $84,200.
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What is your actual tax rate?
In a nutshell, your top marginal rate reflects what you’ll pay on the portion of your income that falls into that top bucket — but your effective rate, or what you actually pay the IRS, is likely to be much lower because of that graduated system.
“With the tax reform in 2018, we have seven brackets that go up as you go up in taxable income,” says Dina Pyron, global leader of EY TaxChat, a tax-prep service from Ernst & Young.
“Your actual tax rate is an average of the brackets” and is typically much lower than your top marginal rate, she says.
The problem, Pyron says, is that a misunderstanding of how tax brackets work can lead to misjudging your tax situation. For instance, if you believe you’ll pay your top marginal rate on your entire income, you could end up overpaying your taxes throughout the year.
“If you have a big refund, some people are really happy, but I consider that money you lost during the year,” Pyron says.
Tax refund myths
Refunds are another tax issue commonly misunderstood by taxpayers. Only half of taxpayers realize that refunds reflect money they already paid, Credit Karma Tax found in a recent survey. Many of the rest believe that refunds are paid by the government, rather than reimbursements of their own money.
The problem is that the IRS doesn’t pay interest on money that taxpayers overpay, which means those workers are giving the government an interest-free loan.
To determine your effective tax rate, you’ll want to divide your total tax by your taxable income. To be sure, the Tax Cuts & Jobs Act created new tax brackets, along with a host of other changes, which went into effect in 2018. That means you’ll want to examine your 2018 return or this year’s data to get a handle on your most recent effective rate.
It’s also important to understand that the IRS typically changes tax brackets annually to adjust for changes in the cost of living. For instance, in November, the IRS issued new tax brackets for 2020, which impact your current earnings. (Your April 15 tax filing this year, however, will rely on the 2019 tax brackets.)
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The brackets moved up slightly, with the lowest rate of 10% now applying to income of up to $9,875 for single filers and $19,750 for married couples filing jointly. In 2019, those limits are $9,700 for single filers and $19,400 for married couples filing jointly.
Aimee Picchi is a business journalist whose work appears in publications including USA Today, CBS News and Consumer Reports. She previously spent almost a decade covering tech and media for Bloomberg News. You can find her on Twitter at @aimeepicchi.
This article originally appeared on USA TODAY: Taxes 2020: Tax brackets, refunds and what you need to know about them
