One thing that surprises a lot of people in the new year is their income tax burden. Estimating the amount we may owe or the amount we might receive back can go a long way in relieving some of this anxiety.

Although the laws change every year (yes every single year), there are some basic amounts that we can use to always have a running general idea of where we stand with respect to income tax. You may have heard terms like Tax Bracket, Adjusted Gross Income, and Taxable Income, but it isn’t terribly complicated.

First, there are the tax brackets or tax percentages. The Tax Brackets for the year are simply the tax percentages associated with each level of income. We use a tiered tax system in the United States so that higher amounts of income are taxed at a higher rate. An example will make this clear and help to apply this to our own situation. Shown below are the tax brackets for filing year 2017 (which applies to moneys earned in 2016).

For a simple example, let’s consider a single person with $30,000 in taxable income. At first glance, it might seem that since $30,000 falls into the row for 15% that the tax would be:

$30,000 in income times 15% tax bracket = $4,500.00

But this tax amount is not accurate. The reason is that the first $9,325 of income is taxed at 10% and then the amount above that is taxed at 15%. By applying 15% to the full amount overstates the taxes. Taking the first part:

$9,325 in income times 10% tax rate = $933.00

The remaining amount ($30,000 minus $9,325) of $20,675.00 is taxed at the 15% rate.

$20,675 in income times 15% tax rate = $3,101.00

Adding the two amounts together gives us the total tax burden.

$933.00 plus $3,101.00 = $4,034.00

Recall that when we simply applied the 15% tax rate, the result was $4,500.00 in taxes which is almost $500 higher than the actual tax amount.

Adjusted Gross Income

Our Adjusted Gross Income is our income after modifications such as unreimbursed business expenses, medical expenses, retirement plan contributions, and others. These modifications to income are considered to be “above the line”, meaning they are taken into account before tax exemptions for military status, dependent status, and the like which are used to determine taxable income.

Taxable Income

Next, let’s consider taxable income. The taxable income amount is not necessarily my gross income for the year (and in most cases it is not). My taxable income is my Adjusted Gross Income minus any exemptions or deduction. This amount is the amount used to determine my tax burden for the year.

Let’s use another example to see how we this might work. In this example we’ll use a married couple filing jointly with $82,000 in combined gross income. Again, just using the tax bracket of 25%, the amount would be:

$82,000 in taxable income times the 25% tax rate = $20,500.00

Breaking the income down into the individual tax brackets results in a much different amount:

$18,650 in taxable income times the 10% tax rate = $1,865.00

Plus, $75,900 minus $18,650 = $57,250 times 15% = $8,588.00

Plus, $82,000 minus $75,900 = $6,100 times 25% = $1,525.00

For a total income tax of $11,978.00 which is about $8,000.00 less than the amount above.

If this couple had exemptions and deductions such as mortgage interest, medical expenses, charitable contributions, or others that modified income, we can see a different result. For the example, let’s assume that the couple’s exemptions and modifications resulted in an Adjusted Gross Income of $74,000.00.

$18,650 in taxable income times the 10% tax rate = $1,865.00

Plus, $74,000 minus $18,650 = $55,350 times 15% = $8,303.00

The total tax burden for the couple would be approximately $10,168.00.

Notice that simply using the 25% tax bracket for this couple resulted in an estimate of $20,500.00. Using exemptions and deductions to reduce income to $74,000, and then applying the tax brackets as they are actually applied resulted in an income tax of $10,168.00. This is a difference of more than $10,000.00 in taxes paid by the couple.

Hopefully this gave you some things to think about that might help you to reduce your tax burden, as well as some ideas for better money management throughout the year.

Thanks for reading.