Taxes can be confusing and stressful. Added to that changes occur on a regular basis.
In calculating the tax you pay, start with your gross income – this is your total income. Then exclusions are applied. Some types of income are excluded from taxes - for example contributions to a 401(k) retirement savings plans are excluded from income. So, contributing in your retirement account can help bring down your taxable income.
Then adjustments are applied. An example of these are: half of self-employment taxes paid or contributions to certain retirement accounts like traditional IRAs. The figure we get after adjustments are applied is called your adjusted gross income or AGI.
Then deductions are taken from adjusted gross income to get to taxable income.
There are two kinds of tax deductions - standard and itemized. The standard deduction is a flat amount whereas the itemized deduction requires calculations, proof of expenses, and an extra IRS form to be filled out at tax time. Tax payers choose which deduction they want to take - standard or itemized. Then the deduction is subtracted from the adjusted gross income, reducing the amount of income subject to income taxes. At this point in the calculation, we arrive at our taxable income.
The US has a progressive tax system where different amounts of your income are taxed at different rates.
There are seven federal tax brackets for the 2022 tax year: 10%, 12%, 22%, 24%, 32%, 35% and 37%.
The bracket you land in depends on a variety of factors ranging from your total income, your total adjusted income, filing jointly or as an individual, dependents, deductions, credits, and so on.
As you acquire more taxable income you start to fill up the 10% bracket. Once this is filled, your next dollar of taxable income is taxed at the 12% rate. This trend continues as you fill up each bracket. This is also where tax credits come into the equation - they reduce the amount of tax you owe dollar for dollar.
One misconception I have seen over the years is folks thinking that their entire income is taxed at the bracket that last dollar of taxable income is in. Thankfully that is not the case. You will likely pay a lower overall or effective tax rate than your tax bracket.