Life's certainties include death and taxes, but yearly changes in tax laws bring uncertainty for all taxpayers. The IRS recently announced a 5.4% increase in the thresholds for each tax bracket for 2024 filings. This marks the second-largest annual increase behind last year's 7.1% hike.
Persistent inflation has driven these historically high adjustments over the past two years. But while inflation has presented challenges for many Americans, in this case, it will benefit taxpayers by causing more of their income to be taxed at a lower rate. See the table below for the adjusted 2024 thresholds for marginal income tax rates.
You probably already know that tax brackets dictate the percentage of income owed to the government, with rates increasing as income rises in the progressive U.S. tax system. A common misconception is that the marginal rate for a tax bracket, as shown in the table above, applies to all income. For instance, a single person with taxable income of $100,000 in 2024, might mistakenly calculate a $22,000 tax liability at a 22% rate. However, your income is taxed as it moves through these tiers: the initial $11,600 is taxed at 10%, the next $35,550 at 12%, and the remaining $52,850 at 22%, resulting in a 2024 tax bill of $17,053 and an effective tax rate of 17.05%. The effective tax rate is the average rate at which an individual's total income is taxed.
The IRS's significant increase in tax bracket thresholds for 2024 may translate to lower taxes compared to 2023, assuming consistent taxable income. If your taxable income increases in 2024, you will still pay a maximum marginal rate of no more than 37% of your earnings, and you will pay a lower percentage on more of your income as it is taxed through the tiered system.
Staying informed about tax bracket changes and understanding the difference between marginal and effective tax rates are important considerations for informed financial decision making. Marginal rates reveal the impact of additional income, while effective rates offer an overall view of the tax burden, aiding proactive financial planning. This awareness ensures alignment of financial choices with long-term goals.