Tax law is the most complicated body of law in the United States. Federal income tax is one of the foundational taxes that affects everyone, every individual, and every business. You can’t escape it if you live and work in the United States. 

Everyone knows a little about income taxes, but there are many misconceptions and over-simplifications. Some people throw around important tax concepts without fully understanding their import. 

One of those critical and often misunderstood concepts is the tax bracket. Finding out how tax brackets are, how they work, and how they apply to you is essential for calculating personal and small business income taxes.   

Some businesses, like corporations, must pay income taxes as their own entity, separate from the owners’ personal income taxes. However, for most businesses, the owner will use their business income as part of their personal tax return. 

What Is an Income Tax Bracket?

Federal income tax brackets are one of the key pieces for determining income tax rates for independent individuals in the United States. They are categories for assessing individual incomes and the proportionate taxes due. They apply to all individual income, whether earned as an employee or a small business owner. 

Each bracket covers an income range and applies a given tax rate for income in that range. When your income goes up, you may find yourself going from one tax bracket into the next. 

Finding the appropriate bracket that your income falls under is the first step to calculating your income taxes.  

Progressive Taxation

The tax bracket system imposes higher tax rates on higher levels of income. Those that make more money pay a higher proportion of their money in taxes. This is what makes the federal income tax in the U.S. a progressive tax. 

On the other hand, a regressive tax means that people with lower levels of income pay a higher percentage of their money in taxes than those with higher incomes. Without tax brackets, every income level would pay the same flat rate in taxes, making income tax a regressive tax, as it would disproportionately burden lower-income earners.  

Marginal Tax Rates

Another essential thing about income tax brackets is that their tax rate only applies to the portion of income that falls into the given range. Each tax bracket is associated with a specific marginal tax rate. It is not a tax rate that applies to all your income but only to the margin under this particular tax bracket. 

If your income puts you in a higher tax bracket, you will pay taxes according to each lower bracket as well. If your highest bracket requires a marginal tax rate of 32%, you will only pay 32% of the income that puts you in that range, even if it is only a minimal amount.  

What is an Effective Tax Rate?

Because marginal tax rates only apply to segments of your income, it takes a couple of steps to figure out what your overall tax rate is. That number is known as your effective tax rate. It represents the final percentage of your total income that you are paying in taxes. It is the average of all your marginal tax rates!

To calculate your effective tax rate, you simply divide your total income by the total taxes you’ve paid. To figure that out, however, you have to calculate how much you owe in each tax bracket separately. 

All of this can make handling your small business taxes quite the challenge, especially for new small business owners just starting.  

What Are the Tax Brackets for 2021?

Here are the income ranges and marginal tax rates for 2021, including adjustments for inflation. The tax brackets apply different rates for single individuals, married couples who file taxes together, and heads of households. 

Single Taxpayers

  • 10% — Up to $9,950
  • 12% — $9,951 to $40,525
  • 22% — $40,526 to $86,375
  • 24% — $86,376 to $164,925
  • 32% — $164,926 to $209,425
  • 35% — $209,426 to $523,600
  • 37% — $523,601 and up

Married Filing Jointly 

  • 10% — Up to $19,900
  • 12% — $19,901 to $81,050
  • 22% — $81,051 to $172,750
  • 24% — $172,751 to $329,850
  • 32% — $329,851 to $418,850
  • 35% — $418,851 to $628,300
  • 37% — $628,301 and up

Heads of Households

  • 10% — Up to $14,200
  • 12% — $14,201 to $54,200
  • 22% — $54,201 to $86,350
  • 24% — $86,351 to $164,900
  • 32% — $164,901 to $209,400
  • 35% — $209,401 to $523,600
  • 37% — $523,601 and up

How do you Determine your Tax Bracket for 2021?

To determine your tax bracket, your first step is to figure out what larger category you fall under. Are you a single taxpayer, filing jointly with a spouse, or are you a head of a household? To qualify as a head of household you must be largely financially responsible for a child, sibling, parent, or another dependent. 

Once you know which marginal tax rate chart applies to you, you can determine your taxable income. Calculate your adjusted gross income minus any eligible deductions, and you’ve got your total taxable income. With that number, you can find the highest tax bracket you fall into. 

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Now you should have everything you need to find your tax bracket and calculate your effective tax rate. A lot goes into this tax process to make things more complicated, but understanding the fundamentals is a good start. 

If you have any questions about your tax bracket or other income tax issues, consider working with a professional tax accountant to lead you through the process. Tax accounting and bookkeeping for freelancers and other small business owners can be overwhelming, and it pays to get advice from someone who knows how the system works. 

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Written by Rudy Robles

Rudy Robles is the Bookkeeping and Payroll Supervisor for the Eastern Team at 1-800Accountant. Prior to 1-800Accountant, he worked in variou...