Federal income tax brackets: what are they and how do they work? 

What are federal income tax brackets?

How do tax brackets work?

There are seven main tax brackets you will fall into: 10 per cent, 12 per cent, 22 per cent, 24 per cent, 32 per cent, 35 per cent and 37 per cent.

As an employee, your income tax will likely be withheld from your paycheck, based on your income and what information you have given your employer on your Form W-4. In this case, your employer will pay your income tax for you. 

But if your income tax isn’t automatically withheld or you are self-employed, you will need to calculate your tax and pay it yourself.

For self-employed workers, you will pay four estimated income tax payments, as opposed to weekly or monthly like traditional employees.

You will be paying as the tax year is in progress, so you can only pay an estimated figure. If you overpay, you can claim a rebate later on.  

What are the income tax thresholds?

Income tax thresholds can vary depending on the health of the economy.

However, the 2021 income tax brackets for single filers were: 

• 10 per cent: $0 – $9,995 

• 12 per cent: $9,996 - $40,525 

• 22 per cent: $40,526 - $86,375 

• 24 per cent: $86,376 - $164,925 

• 32 per cent: $164,926 - $209,425 

• 35 per cent: $209,426 - $523,600 

• 37 per cent: $523,601 or more 

These rates will differ depending on your personal circumstances though.

If you are married and you are filing your taxes together, you will pay less tax on your total income.

So, whereas a single filer will pay 10 per cent taxes on their first $9,995 of the year, a joint marriage filing will pay 10 per cent on their first $19,900. 

To better understand how much income tax you can expect to pay, and how your filing status may impact this, use the Internal Revenue Service’s (IRS) tax withholding estimator. 

What are the federal income tax rates for 2023?

Although the bracket system isn’t changing, the income thresholds for each bracket will be increasing next year.

Federal income taxes are designed to track the Consumer Price Index (CPI) which measures the price of popular everyday items.

If things become cheaper, you will start paying more tax on fewer earnings. Or if, as is the case currently, things get more expensive, income thresholds will also increase, so you may fall into a lower bracket.  

The exact income thresholds won’t be officially announced until around November, but with inflation surging in the latter half of the tax year, it’s inevitable that changes will be made.

In April 2023, the CPI inflation rate stood at 4.9 per cent, and in June 2023, it was 3 per cent.

What is an effective tax rate?

Your effective tax rate is the overall amount of your income that you will pay in tax.

But when it comes to working out how much income tax you will actually pay, working out your effective tax rate can be a little challenging.

This is because federal income tax is structured so that you pay more as you earn more — not based on what your annual salary is projected to be.  

As an example, let’s say you earn $32,000 and you’re a single filer.

As your total salary falls into the 2021 12 per cent tax threshold, you might think that you will pay 12 per cent taxes on your entire salary.

But this isn’t quite right. You’ll pay 10 per cent on your taxable income up to $9,950, and then 12 per cent on the rest of your salary.

Your total tax bill comes to $3,641 — or an effective tax rate of around 11 per cent. 

Or, if you earn a salary of $50,000, you’d pay 10 per cent on your first $9,950, 12 per cent on everything between $9,951 and $40,525, and then 22 per cent on all your other income.

Your effective tax rate would come to 14 per cent.

So, although income taxes may look straightforward, working how much you will actually pay can require a little more calculation.

What are common tax deductions?

Whatever tax bracket you fall into, there are lots of deductions that can help reduce your tax bill.

Whether you take a single standard deduction, or several itemized deductions from your tax bill, you will need to file a Schedule A form to get your deductions paid back.  

Some of the most common tax deductions include medical deductions, such as blindness and disability deductions, homeowner deductions, including property tax and home office deductions, and deductions for charitable donations you make.  

There are also lots of deductions that many people may not be aware of, but might qualify for: 

• Volunteer deductions: If you fund your own voluntary work, you could be eligible for a deduction if you keep good records of your expenses.  

• Student loan interest deductions: You may be able to claim deductions on some student loan interest you paid during the year. 

• Interest on money borrowed for investments: If you borrowed money to invest in an income-earning asset or investment, you can get a deduction for some of the interest you paid.  

• Casualty and theft losses on income-producing property: You can get a deduction for any casualties or thefts impacting any property that produces income for you.  

• Gambling losses deductions: If you have detailed records of your gambling winnings and losses, your losses may be tax-deductible.  

How to lower your tax bracket

The two main ways to lower your tax bill are through tax deductions and tax credits.

As covered above, deductions can lower your tax bill based on some of your financial activity during the year.

You may choose to take a standard deduction, which is a single and fixed amount off your tax, or itemized deductions, which are a list of eligible expenses you can claim back.

However, this requires you keeping extensive lists, records and often rigorous financial planning.  

Tax credits offer an alternative way to reduce your tax bill, and are paid directly to you for certain reasons, such as child tax credits, lifetime learning credits and adoption credits.

Tax credits lower your overall tax bill, but they won’t move you directly into a lower tax bracket.