Understanding How Federal Taxes Affect You

By Jon L. Ten Haagen, CFP ®

You work all year earning a living and then in April of the next year the government comes calling and asking you to contribute to their coffers. You and or your certified public accountant are obliged to gather information and details of your income and outgo. It is wise for you to understand your tax bracket, your filing status and which income tax rate(s) apply to you. Depending on your filing status and how much taxable income you earned will determine how much tax you will owe (Irs.com/articles/what-is-tavable-income-2).

We will discuss marginal income tax brackets, federal filing statuses, and income tax rates. Hopefully this will help you prepare a tax strategy. You are obliged to pay taxes, however you are not obliged to pay the maximum tax if you work with a good CPA on ways to reduce your tax obligation legally.

Marginal tax brackets basically represent the highest tax rate that you must pay on your income. There are six marginal tax brackets currently which are 10-, 15-, 25-, 28-, 33- and 35-percent. This is a gradual tax schedule, which states that the more you earn the more tax you owe. The amount you earn determines your bracket and how much tax you are obliged to pay. Please note that if and when you earn more and are put into a higher tax bracket, it is only the amount you earned in the higher bracket which is taxed at the higher rate. All earned income below that bracket is taxed at the lower rate.

The structure of federal income tax brackets was implemented by the Internal Revenue Service near the turn of the century to create a progressive tax system which would ask less from lower-income households. This system plus a few tax credits and deductions have made it so nearly half of Americans avoid owing federal income tax altogether.

Your filing status is determined by a number of things: your standard deduction amount, your eligibility to qualify for certain tax credits and tax deductions, and your income tax. There are five Federal Filing Statuses based on Marital Status and other conditions: Single, Married Filing Separately, Married Filing Jointly, Head of Household and Qualifying Widow(er) with Dependent Child.

Single: if you are unmarried, divorced, legally separated, or widowed as of the last day of the calendar year (Dec. 31).

Married Filing Separately: a married couple can decide to file a joint income tax return or file separate returns. There are a number of reasons couples may decide to file this way. Please check with a competent tax advisor because this method is complicated and could be less beneficial. It is best to calculate under both ‘separate’ and ‘joint’ to determine which is best for them.

Married Filing Jointly: couples must file only one combined tax return and they will jointly be responsible for the income reported and taxes owed. They must be legally married as of the last day of the applicable tax year. This method offers married couples more tax benefits.

Head of Household: you can file “Head of Household” if you are unmarried on the last day of the year (Dec. 31). This is typically used by single parents who have custody of their children. Again, this is a complicated area with lots of rules, so get advice from a qualified tax advisor.

Qualifying Widow/Widower with Dependent Child: this method may only be used by a widow(er) who lives with a Dependent Child and is not married. This applies in the year your spouse passed away and can be used for two years after your spouse’s death. This filing status allows individuals to use the same tax rates as those who are ‘Married Filing Jointly.’

Make sure you are looking at the IRS tables showing the year of filing you are seeking. Just about each year there are small changes to the IRS codes. Please make sure you are working with a competent qualified tax advisor so you do not get a letter from your favorite group – the IRS. Also it is a good idea to seek out a qualified financial advisor. A CFP is a very good start to find the best investment path for you to pay as little tax as possible and get the best well diversified investment program to fit your specific needs.