You’ve probably come across online tax calculators before. However, if you don’t know exactly how income tax is calculated, then they probably aren’t going to tell you a whole lot. So how exactly is your income tax calculated, and what can you do to lower the amount of money you owe to the government? Here’s some helpful information from our tax service in Des Moines, IA.
Tax brackets
The way your taxes are calculated depends on the tax bracket in which you fall. It’s worth noting that “tax bracket” and “tax rate” don’t mean the same thing. There’s a misconception that if, for example, you fall in a tax bracket that taxes at 30 percent, that means you give up 30 percent of your income. However, that’s not true—you’d only be taxed 30 percent on the amount of income you have that falls within that bracket. This is what’s called a “marginal” rate.
Let’s say, for the sake of this example, that there are tax brackets A, B, C and D that tax at five, 10, 15 and 20 percent. Bracket A covers income from $0 to $25,000, B covers $25,000 to $50,000, C covers $50,000 to $75,000 and D covers $75,000 to $100,000. If you made $80,000 in a tax year, only $5,000 of that would actually be subject to the highest tax rate. The other portions would be subject to the first three rates.
Income
Tax calculators will, of course, consider your income. This includes earned salaries, wages and other types of compensation, such as investments and rental properties. Your adjusted gross income (AGI) is the amount of taxable income you have after subtracting IRA or HSA contributions and other exceptions.
Filing status
Your filing status also influences how your taxes will be calculated. You can file as Single, Married Filing Jointly, Married Filing Separately, Head of Household or Qualifying Widow(er).
Deductions and credits
While the Tax Cuts and Jobs Act did eliminate a lot of deductions that previously existed in the tax code and boosted the standard deduction to the point where fewer people itemize than ever before, it does still make sense for some people to track their deductions, all of which will affect how your income taxes are calculated.
While deductions lower the amount of taxable income you have, credits are dollar-for-dollar reductions of the amount of income tax you owe based on your eligibility. In some instances, these credits are refundable, which means you’ll get paid amounts of the credit that are greater than your tax liability. Some credits have recently changed, such as the child tax credit, so it’s important to go over the existing credits with your tax service in Des Moines, IA and check your eligibility. Regardless, you can bet that these credits and your eligibility for them will factor into calculations.
For more information about how your income taxes are calculated and what the numbers that come out of an income tax calculator actually mean, contact the team at Accounting & Tax Professionals, PLC today.