Tax Brackets and Effective Tax Rates: What You Need to Know

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Want to maximize your taxes? Learn how tax brackets works and legit ways on how you can lower your taxable income and qualify for a bigger tax refund!

With January here, taxes are on our minds.

Over the last few years, we've developed a rhythm and system. As the paperwork comes in I stash it in a folder until the end of the month when I start getting the information into TurboTax .

We usually review notes that TurboTax included with our tax returns. they typically include a tip or two on how we can optimize for the next year.

There's also a section showing our effective tax rate, which I'm always curious about.

There's a lot of confusion around tax brackets and tax rates so I wanted to just briefly talk about the two today.

I also want to share how you can lower your taxable income.

What are Tax Brackets and How They Work?

In the United States, there is a progressive tax system, which basically means that as your taxable income grows, so does your tax rate.

They can (and do) change every year, so you have to check with IRS to see the current numbers.

Here's a chart of 2018 tax brackets for those married filing jointly:

How Tax Brackets Work

Let's use an example to show how tax brackets work for many families.

Suppose you're married, filing jointly and your household income for 2018 was $78,000.

Here is how your taxes are calculated with the brackets:

• Your first $19,050 will be taxed at 10%.
• Your income from $19,051 to $77,400 will be taxed at 12%.
• The remaining amount will be taxed at the 22% bracket.

So even if you're in the 22% tax bracket, most of your income is taxed at a lower amount.

Effective Tax Rates – What's Coming Out of Your Wallet

Effective tax rates are what you actually pay on all of your taxable income.

To figure out what your effective rate was last year, pull out your 1040 and find your total tax paid and divide it by your taxable income.

You may be surprised at how low it is compared to the highest tax bracket your income falls into.

Still, you may wonder if you can decrease your effective tax rate even further.

It's possible. And yes, it's legit.

How to Pay Less Taxes and Build Wealth

The key to paying less taxes is making sure you maximize all the tax credits and deductions you qualify for.

The two get mixed around, but there is a big difference between them.

Tax deductions reduce your taxable income, not the tax burden that you owe.

The big news with this taxes this year is the standard deduction has increased.

For those married filing jointly, the standard deduction is $24,000. This is a big jump from 2017's standard deduction of $12,700.

The big plus with the standard deduction is that it's much easier when it comes to filing. You can use this deduction no questions asked.

Itemizing your deductions means making sure you have the documentation on hand to prove you qualify for your deductions.

Since you can't take the standard deduction and itemize your deductions, run the numbers so you make sure you choose the best financial option for your situation.

If you're using tax software (like TurboTax ), it's fairly easy to see the numbers in both scenarios.

Tax credits, though, lower your tax bill. If your tax credits are refundable and they exceed what you owe, you may qualify for a tax refund.

Some big tax credits you should look at include:

• Child and Dependent Care Credit
• American Opportunity Tax Credit
• Lifetime Learning Credit

Another opportunity to lower your taxable income and build up wealth is making sure you're taking advantage of all available tax-deferred savings options.

Contributing to retirement accounts like a 401(k), 457, or 403(b) allows you to invest while lowering your taxable income.

If you have a high deductible health plan, you can contribute money in a Health Savings Account (HSA).

If you want more information and tax tips, check out my tax series here on Couple Money or my contributing posts on TurboTax.

Thoughts on Tax Brackets and Tax Rates

I'd love to get your take on taxes. How big of a difference between the tax bracket you're in and the effective tax rate you're paying?

What tax credits and deductions have you taken?

Are you getting ready to start filing your taxes? Check out TurboTax. We've used them for years and love how easy it is to get our taxes done.

This article was originally published in March 2012. It has been updated January 2019.

This post may contain affiliate links. Please read my full disclosure for more info.