When handling expat tax, most people find trouble in navigating the basics of taxation. They have a hard time choosing their correct and optimal filing status, figuring out the best payment method, or identifying what tax bracket they are in.
Tax brackets are essential tax basics you should understand. By knowing what federal tax income bracket your earnings fall into, you can avoid the attention of the Internal Revenue Service (IRS) and find a strategy to reduce your federal tax bill.
Generally, tax brackets change every year, so you should always be up to date with your brackets. With this, we’ve rounded up some effective tips on how you can determine your tax bracket and calculate what bracket you belong in.
Learn the different tax brackets
Before exploring the different tax brackets, you must know what they are. Tax brackets determine how much you need to pay the IRS every year. The tax amount will depend on your income—as your taxable income increases, so will your tax rates.
For ordinary income, tax brackets currently have seven segments: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. With this progressive tax system, you don’t have to pay the same rate on every dollar earned, but instead, you pay higher rates on each dollar that exceed a particular threshold.
To determine which tax bracket your earnings fall into, you need to know your filing status, taxable income, and the difference between marginal and effective tax rates.
Know your filing status
Some expats fall into more than one tax filing status. With this, you can pick the status that you can benefit from the most. Here are the different filing statuses:
- Married filing jointly
- Married filing separately
- Head of household
- Qualified widower
Determine your taxable income
To identify your tax income, you must do several calculations.
Calculate your gross income. Add all your earnings, including your salary, rental income, and side hustles. Then, subtract the income considered as an exclusion by the tax code. Non-taxable income includes child support and welfare. However, this does not include foreign earned income eligible for the foreign earned income exclusion. This must be included in order to determine your tax bracket.
Calculate your adjusted gross income. Once you have your gross income, subtract certain tax adjustments like your student loan interest, health savings account deductions, or contributions to Individual Retirement Accounts (IRAs).
Subtract tax deductions. There are two ways you can claim your tax deductions, but you can only choose one.
Take the standard deduction. Standard deduction refers to a flat-dollar reduction in which the amount to be deducted will depend on your filing status. For example, single filers can get a $12,550 deduction for the 2021 tax year, while it’s $18,800 for the head of household filers.
Itemize deductions. You can cut your taxable income by choosing from the available tax deductions you qualify for. The more you can deduct, the fewer taxes you pay. Some examples include charitable donations and self-employment expenses.
For expats, you can file for the Foreign Earned Income Exclusion (FEIE) that excludes a certain amount ($108,700 for 2021 tax year) of your foreign earned income from U.S. tax.
After you’ve computed your tax deductions, you’ll get the amount for your taxable income. With this, you can determine your taxable income in most situations.
Differentiate marginal tax rate vs. effective tax rate
Based on the tax bracket, you may think that if your income and filing status fall at a certain tax rate, you’ll have to pay your whole income to that tax rate. However, that’s not the case. The tax bracket is a progressive system, which means it can get more complicated.
For example, you’re a single filer, and your taxable income in 2021 is $50,000. It means that your income will fall into the 22% bracket, but it doesn’t mean that your $50,000 income will be taxed at 22%. This is just the marginal tax rate.
You’ll have to compute your effective tax rate to determine how much your total tax liability is. To do this, you would have to work your way up the tax brackets. Based on the $50,000 income example, here’s how (refer to the 2021 federal income tax brackets and rates):
- Start by paying 10% for the first $9,950 of your income.
10% x $9,950 = $995. This is the first amount of your taxes.
- Then, pay 12% for the chunk of income between $9,951 and $40,525.
12% x $30,574 ($40,525 – $9,951) = $3,668.88. This is the second amount of your taxes.
- Next, pay 22% on the rest, which means the chunk of income between $40,526 and $50,000.
22% x $9,474 ($50,000 – $40,526) = $2,084.28. This is the third amount of your taxes.
- Finally, add all three tax amounts to get your tax bill, which is a total of $6,748.16.
When you have the total tax amount, you can determine the effective tax rate. For this example, the total tax liability amount is $6,748.16, which is around 13% of your taxable income. So, even though you’re in the 22% tax bracket, you’ll only pay 13% or your effective tax rate.
Check if you can lower your tax bracket
You can use strategies to lower your tax rate, especially if your taxable income falls right on the cut-off between brackets. Before the tax year ends, you can consult with experts from tax resolution companies like Tax Samaritan to find ways to lower your tax bracket.
Some common strategies people do are delaying their income and making certain contributions. If you’re considering itemizing deductions, you can make year-end charitable contributions.
Understand Your Tax Bill
For most people, calculating taxes is a chore, maybe because they’re unfamiliar with how to do it. A great first step into understanding your taxes is to know your tax bracket. Once you’ve learned how they work, everything else should fall into place.
If you’re looking for a tax resolution partner to help you out, Tax Samaritan offers best-in-class tax services for expats.