Income Tax: A Slice for Uncle Sam

Income tax may be something most of us take for granted. But how does it work?

https://tickertapecdn.tdameritrade.com/assets/images/pages/md/Slice of income tax for the IRS
5 min read
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Key Takeaways

  • About half of the total U.S. federal revenue comes from income taxes
  • Federal tax rates for individuals are currently broken into seven brackets, ranging from 10% to 37%, based on income level 

  • Contributing to a retirement plan is one way to potentially reduce your taxable income 

Income tax on your mind? In his roughly 30 years as a tax professional, Michael Rice, corporate tax director at TD Ameritrade, has spent his share of time poring over U.S. tax laws and rules. And there’s plenty to digest. He remembers physical copies of the tax code filling two volumes that were about two inches thick. And that didn’t even include all the regulations, which filled another six books of similar thickness.

“There’s been talk as long as I’ve been around about simplification,” said Rice.

Thankfully, the vast majority of individual taxpayers don’t have to worry about most of what’s in those ponderous tomes. Many of the rules focus on corporations, tax-exempt entities and other arcane provisions most individuals will never have to deal with.

But what many taxpayers do need to worry about is income tax. Through the week ended November 23, the Internal Revenue Service says it processed more than 154 million individual tax returns and issued more than $324 billion in tax refunds in 2018. Those refunds averaged $2,899.

Individual taxes on income provided around half of the federal government’s revenue in 2017, according to the Tax Policy Center. That’s the biggest single contributor to the federal coffer, beating out payroll tax, corporate income tax, and excise tax.

One of Congress’s jobs is passing legislation regulating individual income taxes. The last major overhaul came in late 2017, affecting the 2018 tax year, for which people are supposed to file returns by April 15 of this year. Although Congress is in charge of writing the tax laws, it’s the Treasury Department that collects federal taxes via the Internal Revenue Service (IRS).

Brackets: Not Just for Basketball

As its name suggests, this involuntary contribution to Uncle Sam is a tax on one’s income.

According to Kathy Keylor, director of tax services with MAI Capital Management, financial benefits can generally be thought of as falling into three categories: gift, inheritance, or income.

The government’s slice of the pie from your income is determined on a scale based on how much you make. This continuum is divided into income tax brackets, which gives people a slightly less enjoyable form to deal with along with their March Madness basketball brackets.

“They tax you at a certain rate based on your income level,” Keylor said.

For the 2018 tax year, this tiered system includes federal tax brackets of 10% for low earners, up to 37% for high earners, with several thresholds in between. How much you earn and your filing status determines which bracket you fall into. For example, a single filer whose taxable income is between $38,701 and $82,500 would fall into the 22% bracket. There’s also a zero-percent rate, such as for certain long-term capital gains. See the table below for the 2018 federal income tax brackets.

2018 Marginal Tax Rate
Income Level (Single Filers)
Income Level (Married Filing Jointly)
10%Up to $9,525
Up to $19,050
12%$9,526 to $38,700
$19,051 to $77,400
22%$38,701 to $82,500
$77,401 to $165,000
24%$82,501 to $157,500
$165,001 to $315,000
32%$157,501 to $200,000
$315,001 to $400,000
35%$200,001 to $500,000
$400,001 to $600,000
37%Over $500,000
Over $600,000

“The more taxable income a taxpayer has, the higher the rate that is paid on that income,” Rice adds. He notes that these thresholds are marginal, meaning as you move up the income scale, the higher tax rates are assessed on income over and above the previous threshold. So, for example, if you are a single filer with an income of $80,000, you’ll pay 10% on the first $9,525, 12% on the next $29,175 (the difference between $9,525 and $38,700), and 22% on the rest.

Each year, the government adjusts the amount of income that falls into the brackets to account for inflation. So for the 2019 tax year, the income threshold for single filers in the 22% bracket rises to between $39,476 and $84,200. That’s roughly 2%.

State of Change

The rule changes from the 2018 tax year to the 2019 tax year aren’t as dramatic as the Tax Cuts and Jobs Act of 2017, which included a reduction in the tax rates for most of the income tax brackets, an increase in the standard deduction, an elimination of the personal exemption, a lowered mortgage interest deduction, and a cap on the amount of state and local taxes people can deduct.

Perhaps one of the most noticeable changes from the 2018 to 2019 tax years is that the penalty for being uninsured was eliminated at the beginning of this year.

Income Taxes and Your Retirement

In addition to the inflation adjustments for the brackets, the annual contribution limit for a 401(k) retirement account has risen to $19,000 for 2019, up from $18,500. For Individual Retirement Accounts (IRAs), the contribution limit rises from $5500 in 2018 to $6000 in 2019.

Keylor encourages her clients to max out their retirement accounts if they can. At minimum, if an employer offers matching contributions, consider contributing at least to the limit of the company match. “It’s basically free money,” she said.

She also encourages clients to max out their health savings account and don’t spend those funds if possible. “You can let it grow and build and use that for your care in retirement,” she said.

As an added bonus, traditional 401(k) plans are tax deferred, meaning you don’t pay taxes until withdrawals are taken, typically in retirement. So the amount you contribute is subtracted from the income you earned that year, which means Uncle Sam takes a smaller slice, at least for now.

TD Ameritrade does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances.

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Key Takeaways

  • About half of the total U.S. federal revenue comes from income taxes
  • Federal tax rates for individuals are currently broken into seven brackets, ranging from 10% to 37%, based on income level 

  • Contributing to a retirement plan is one way to potentially reduce your taxable income 

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