Do You Pay a High, Moderate or Low Income Tax Rate?

There are currently seven U.S. Federal income tax rates in the IRS tax tables ranging from 10% to 37%.  On closer inspection though, there are effectively 4 “groups”: Zero, Low, Moderate, and High. 

Taxes on Salary vs. Taxes on Taxable Income:

Most people know their salary or “ordinary income”, not their taxable income, so the published IRS tax brackets can be hard to translate into your personal situation.  Since most Americans (estimated at 90%) now utilize the Standard Deduction(1), it is helpful to add that onto the taxable income limits that are found in the IRS tax tables.  This has been done in the table here.  Also, there is no 0% tax bracket in the IRS tax tables, but the Standard Deduction effectively creates one.

Tax Rate Groups based on “Ordinary” Income

considering the Standard Deduction(2) 

The Standard Deduction in 2020 is $24,800 for married couples, filing jointly and $12,400 for single filers

Your Average Tax Rate is Lower

The tax rates shown in the table are applied to each additional dollar you earn (also known as marginal tax rates), so the average tax rate that you pay on your income will always be less than your marginal tax rate.  For example, for a married couple with

     “Ordinary” income = $120,000

  • Pay a tax rate of 0% on the first $24,800
  • Pay tax rates of 10% and 12% on the next $80,250 (=$105,050-$24,800)
  • Pay a tax rate of 22% on the final $14,950 (=$120,000-$105,050)

       Net result = about $12,700 in federal income tax owed for 2020.

  This is an average or “effective” federal income tax rate of 10.6% (=$12,700/$120,000). 

What about Social Security and Medicare (aka FICA) taxes?

Before getting too excited about this “low” 10.6% average tax rate, don’t forget that you are also paying two other taxes to the Federal government.  You are paying 6.2% for Social Security (up to $137,700 of ordinary income) and 1.45% for Medicare (no income limit), so your effective, average tax rate is about 18% on $120,000 of income.

Your Actual Taxes are probably more complicated!

Other tax rates may apply if you have any “non-ordinary” income, like from stocks, depending on the investment.  IRA or 401(k) contributions can lower both your marginal and effective tax rates.  Also, there are many other tax deductions that may lower the income limits shown in the table, and tax credits that will lower your effective tax rate.

Bottom Line:

The more money you make, the more income tax you pay, but this is not a straight-line relationship.  Because of the Zero, Low, Moderate, and High tax groups, the relationship between your income and your Federal taxes has some significant bends in it.  It is helpful to know what tax group you are in so that you can plan accordingly.  For example, you may want to increase your 401(k) contribution before year’s end to keep you from bumping up into a higher tax rate group for 2020.

References:

  1. Urban-Brookings Tax Policy Center. Table T18-0002. “Impact on the Number of Itemizers of H.R.1, the Tax Cuts and Jobs Act (TCJA), by Expanded Cash Income Percentile, 2018.”
  2. IRS Provides Tax Inflation Adjustments for 2020

Income tax groups

Krehbiel Financial LLC

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