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"TAX" in block lettersWith the 2021 tax deadline just around the corner it’s not too soon to acquaint yourself with the relevant federal tax brackets. The Internal Revenue Service (IRS) adjusts them annually for changes in the cost of living. Those changes may impact your tax payment strategy. With that in mind, here are the marginal tax rates for the 2021 year. A financial advisor can help you with tax planning. Find an advisor today.

What Is a Marginal Tax Rate?

A marginal tax rate is the amount of additional tax you incur for added levels of income. The United States imposes a progressive tax system. So, the more that you earn, the higher the tax bracket your income falls in. The exact range then determines the tax rate you effectively pay, although nominally those earning more income face a greater tax burden. In turn, that means you, as the taxpayer, keep a smaller amount of money per dollar earned than you would under your level of income.

Your marginal tax rate solely applies to your taxable income. That means it’s based on funds once you subtract your standard or itemized deductions from your gross annual income.

But it’s not taxed at a flat rate. For example, suppose you earn $100,000 in taxable income during 2021. $100,000 hits the 24% tax bracket for single filers, but that doesn’t mean you get hit with a 24% tax bill. Marginal tax rates only apply to the portion of income that falls directly within that bracket.

To illustrate, let’s say you earned $9,960 in taxable income in 2021. You would pay 10% on the first $9,950. That’s $995. Then you would pay 12% on the remaining $10 for $1.20 in tax. Overall, you pay $996.20 in taxes during the year.

Marginal Tax Rate vs. Effective Tax Rate

Both marginal and effective tax rates help taxpayers find out how much they owe the IRS. But, effective tax rates are slightly different.

Effective tax rates are based on your annual income and your total income tax liability. To find yours, simply take the latter and divide it by your gross annual income. The result is the percentage of annual income you should pay in taxes.

For instance, if a person made $150,000 this year then that person would pay the IRS $37,500 in taxes. As a result, their effective tax rate would be 25%, meaning this person paid 25% of his or her income in taxes.

In contrast, marginal rates are progressive and comprise of seven tax brackets. Generally, the more you earn, the more likely you should use marginal rates as your measurement tool. If you find your income falls into one of the lower brackets, you can probably use the effective rate more reliably.

2021 Marginal Tax Rates

Marginal tax rates include seven brackets at 10%, 12%, 22%, 24%, 32%, 35% and 37%. Where you fall will depend on your filing status (single, married couple filing jointly, head of household) and the amount of income you earn yearly.

Here are the marginal tax rates for 2021, according to the IRS:

Marginal Tax Rates for 2021
Tax Rate Single Filers Married Filing Jointly Heads of Households
10% ≤ $9,950 ≤ $19,900 ≤ $14,200
12% > $9,950 > $19,900 > $14,200
22% > $40,525 > $81,050 > $54,200
24% > $86,375 > $172,750 > $86,350
32% > $164,925 > $329,850 > $164,900
35% > $209,425 > $418,850 > $209,400
37% > $523,600 > $628,300 > $523,600

Remember: you don’t pay a fixed percentage across your overall income with marginal tax rates. Instead, you portion out your income as it falls in each tax bracket. Then, you pay the corresponding rate on that specific range of income. So, your first dollars receive the lowest rate and the latest dollars receive the highest.

Ways to Cut Your Tax Bill

There are a few ways you can reduce your taxable income. The right method may depend on your financial and personal situation, though. Some suggestions worth consideration are:

Set up a College Savings Fund

Calculator with 2021 tax documents

For example, some can reduce their tax bill by creating a college savings fund. When you contribute to a 529 plan, one of the ways to save for tuition, you can possibly take advantage of state-level tax deductions. Furthermore, distributions and earnings made through the account grow tax-free when you use them for qualified expenses.

Save for Retirement

Retirement accounts provide similar opportunities. When you fund accounts like 401(k)s and IRAs, you do so with pre-tax dollars. Thereby, contributing to them lowers your taxable income for the year. Health savings accounts (HSA) allow you to take advantage of the same benefit but for medical expenses, as well.

Make a Charitable Contribution

Alternatively, you can make charitable contributions to reduce your tax bill. Donating assets or cash to a qualified nonprofit organization allows you to lower your taxable income amount. This requires you to itemize your tax deductions, though.

However, if you take the standard deduction in 2021, you can deduct up to $300 per tax return of qualified contributions. It remains $300 for other filing statuses outside married couples filing jointly, who can deduct up to $600.

Harvest Investment Losses

Tax-loss harvesting is a strategy investors often use to limit their short-term capital gains, thereby offsetting their tax liability. Essentially, you sell off investments that have an unrealized loss and report those losses. That can help reduce your tax bill significantly since short-term capital gains may receive higher taxation rates than long-term capital gains.

Short-term gains tend to equal your regular tax bracket rate, whereas a long-term gain tax rate is either 0%, 15% or 20%.

Use Tax Credits

There are various tax credits available to a number of Americans. They’re a dollar-for-dollar reduction on the taxes you owe, not just your taxable income. They may apply on a federal or state level, depending on their type.

Since they vary in type, they help a wide range of citizens. For example, families who adopt children can use the federal adoption credit to offset costs the adoption incurs.

The Bottom Line

Male accountant preparing taxesWhile it would be nice if the rules of taxation stayed the same year to year, they often don’t. They’re subject to change due to factors like current events and inflation. So, it’s vital to review the requirements before tax season rolls around. Knowing and planning for your rate of taxation can help you plan your finances ahead of time.

Tips for Filing Your Taxes

  • A well-planned tax strategy can help you save funds every year. That’s where a financial advisor comes in. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Understanding your finances is key to an airtight tax strategy. Use our tax calculators, like the federal income tax calculator and property tax calculator, you can plan ahead and achieve your goals.
  • It’s also recommended to check out the best tax filing software available. With technology on your side, you can smooth out the entire process.

Photo credit: ©iStock.com/Eoneren, ©iStock.com/Krystsina Yakubovich, ©iStock.com/Stella_E

Ashley Kilroy Ashley Chorpenning is an experienced financial writer currently serving as an investment and insurance expert at SmartAsset. In addition to being a contributing writer at SmartAsset, she writes for solo entrepreneurs as well as for Fortune 500 companies. Ashley is a finance graduate of the University of Cincinnati. When she isn’t helping people understand their finances, you may find Ashley cage diving with great whites or on safari in South Africa.
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