2021 Tax Brackets — How They Actually Work

Taxes are a significant part of your financial plan. They can reduce your overall earnings and eat into your investment returns. Taxes are also a wide subject that engulfs your income, estate, inheritance, short term and long term capital gains, filing status, and a lot more. This is why it is crucial to understand what taxes are, how they work, and how they affect you.

Every year, the income brackets are changed. New provisions may be introduced, exemptions can be altered, the tax brackets can be modified, and the impact of all of these can hamper your earnings. Hence, it may be advisable to find out what the tax brackets are for each year, before you start planning your finances for the financial year.

2021 tax brackets were announced on October 20, 2020, by the Internal Revenue Service (IRS). In order to file your income tax efficiently, here’s a detailed explanation of the 2021 tax brackets and how they actually work.

2021 tax brackets

There are 7 different income tax rates this year that will be levied based on your total income of the year. Just like before, the tax rate will be charged differently for single taxpayers filing individually, the head of the household, married taxpayers filing separately, and married taxpayers filing jointly. Here are the 2021 tax brackets:

Standard deduction for 2021

The standard deduction for 2021 has been increased. The new figures are as follows:

2020 tax brackets                                            

Here are the tax brackets for the year 2020. This table will allow you to compare the two tax tables and understand the differences made by the IRS for the year 2021.

How do tax brackets work?

In order to understand how these tax brackets work, you need to ascertain your total annual income. The government charges income tax based on the money you earn in a year. To find the precise percentage of income tax that you owe to the government, you need to refer to the table of tax brackets for the year you file your taxes. You can find your tax percentage next to the filing status you opt. The filing status differs for each taxpayer. So, if you are the head of the house, your tax liability will be different from if you were a married couple filing your taxes jointly. Similarly, a married couple filing their taxes separately will adhere to a different tax bracket.

The U.S government follows a progressive tax system to ensure equality among all taxpayers. Here’s how this is calculated.

Let’s assume that your total taxable income for the year is $100,000 and you are filing as the head of the household. Your income will be divided into different portions as per the tax brackets, starting from 10%. Following the tax bracket table, here’s how you can calculate your income tax:

• The first $14,200 of your income will be taxed at 10%.
• The next 54,200 will be taxed at 12%. However, you will deduct 14,200 from this figure and pay 12% income tax on the remaining, i.e., $54,200- $14,200 = $40,000.
• Similarly, the next $86,350 will be taxed at 22%. However, you will deduct $14,200 and 40,000 from $86,350 and pay 22% income tax on the remaining, i.e., $86,350 – $14,200 – $40,000 = $32,150.

So, your income tax will look like this:

• You will owe an income tax of 10% of $14,200, i.e. $1,420.
• You will owe an income tax of 12% of $40,000. i.e. $4800.
• You will owe an income tax of 22% of $32,150 i.e. $7073.

Now that you know the 2021 income tax brackets, here are some other taxes that you must know.

Capital gains taxes

The income that you earn from the returns on your investments, such as stocks, mutual funds, etc., is referred to as your capital gains. These earnings are taxed differently than your ordinary income if you hold the assets for more than a year. If you realize profits on selling your investments in less than a year, the returns are considered short term capital gains and added to your total income for the year. They are then taxed as per the tax brackets given above.

However, long term capital gains held for more than a year are taxed differently. The long term capital gains tax brackets for 2021 are given below:

Earned income credit

The earned income credit is a relaxation offered to low and middle income taxpayers in the country. An income credit reduces the overall taxable income for you if your yearly income is already low. This allows families to reduce their tax liability. The income credit is offered as per the income, the number of children in a family, and the filing status of the tax filer. The earned income credit for 2021 is as follows:

So, if you are a single taxpayer with one child, and have an income of $42,158 in a year, an earned income credit of $3,618 will be deducted from $42,158. So, your total taxable income will be reduced to $42,158 – $3,618 = $38,540. You will then refer to the tax brackets as per your income of $38,540.

There are some eligibility criteria to qualify for an earned income credit. Married taxpayers filing their income tax separately do not qualify for an earned income credit. In addition to this, only U.S citizens between the ages of 25 and 65 are eligible to get an income credit. You must also be living in the country for more than 6 months of the tax year to be eligible for an earned income credit.

Apart from the above, the earned income credit in the case of adoption of a child with special needs is $14,440.

To sum it up

When it comes to paying income tax, the U.S government’s tax system can get confusing for a lot of people. Therefore, a thorough understanding of the income tax system is needed as it can help you plan your expenses, investments, and savings accurately. Since tax brackets change as per inflation, it may be advisable to keep a tab on these modifications and plan your deductions and savings accordingly. It also helps to understand long term capital gains taxes, as these can offer more benefits than small term capital gains taxes. This helps you plan the right time to sell your assets.

Keep in mind that the taxes charged on your profits may sometimes impact your future financial goals. So, it may be beneficial to consult a professional financial advisor.

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