The US is a federal government, the federal and the state governments have separate taxation rules. The Internal Revenue Service or IRS is responsible for administering the federal government tax laws. Routine jobs, like adjusting the tax rates to compensate for inflation, are done by them. IRS has already declared the various slabs of income, the corresponding tax rates, and exemption limits. IRS takes the Consumer Price Index to calculate the inflation rate of the previous year and estimates the adjustments to the income thresh holds, credit values, and deduction amounts. This exercise is to avoid last year’s income group climbing up to the next slab just because of the numerical increase in incomes and unadjusted deduction will leave the taxpayer poorer for no faults of his. This phenomenon is called ‘bracket creep.’
The current federal tax brackets (or tax slabs) and corresponding taxes, deductions, etc are applicable for tax returns to be filed in April 2018. The gross incomes from which the standard deductions and allowable deductions like 401(k) contribution etc. subtracted are the taxable income. Taxation starts at a taxable income from nil to $9,325 at the rate of 10% which means one with a taxable income of $9,325 will pay $932.50 as a tax. The next slab is from $9,325 to 37,950, and the tax would be at the rate of 15%. The total tax incidence would be $932.50 for income up to $9,325 and 15% of the amount exceeding $9,325. At the end of the slab the tax incidence would be $932.50+15% of $37,950 – $9,325 = 4293.75+932.50 =$5,226.25. Similarly, tax calculated for the next slab from $37,950 to $91900 will come to 5,226.25 + 25% of the amount exceeding $37,950. At the end of the slab i.e., $91,900 the tax due would be $18,713.75. The next slab is $91,900 to $191,650 taxed at the rate of 28%, and the tax amount would be $18713.75 + 28% of the amount exceeding $91900. The next slab is $191,650 to $ 416,700 and the tax would come to $46,643.75 + 33%of the amount exceeding $191,650. The end of the slab tax would be $ 120,910.25 + 35% of the amount over $416,700 with the end of slab tax $121,505.25. The final slab is $418,400 or more taxed at 39.6%. The tax would be $121,505.25 + 39.6% of the amount exceeding $418,400. This arrangement of taxing makes tax credit and deductions highly valuable. Often these would reduce one’s taxable income to the lower slab. The above calculations are for a single filer. Similar calculations are there for Married Filing Joint Income Tax and Head of Household filers and qualified windows with different slab values but same tax rate.
Standard deductions for single filer goes up by $50 and becomes $ 6,350 and for Married filing jointly goes up to $12,700, and for the Head of Household, it becomes $9,350. Personal Exemption remains at $4,050.
There are two provisions in American tax laws that increase the tax dues of higher income groups. One is called PEP and is the phase-out of the personal exemption. Another is Pease, named after the senator, Donald Pease who introduced it. This is phasing out most of the itemized deductions. The income limits for both are $261,500 for single filers and $ 318,800 for married couples filing jointly. PEP will end up at $384,000 for a single filer and $436,300 for married couple jointly filing respectively. This means taxpayers with AGI above these limits will not get the benefit of personal exemptions.
Earned Income Tax Credit Deductions will also be phased out. For Single or Head of Household, the Income at Maximum credit is $ 6670 for no children, Maximum credit is $ 510 while the phase-out starts at $8,340 and ends at $15,010. For one child Income at Maximum credit is $10,000 and the Credit is capped at $3,400, The phase-out starts at $18,340 and ends at $39,617; for two children Income at Maximum Credit is $14,040 and the credit amount $5,616. The phase-out begins at $18,340 and ends at $45,007; for three or more children Income at Maximum Credit is $14,040 while the maximum credit is $6318. The phase-out begins at $18,340 and ends at $48,340. By the time the phase-out ends the credit amount has gradually reduced and fallen to nil. For married couples filing jointly, the Income and the credit are the same, the phasing out begins and ends at higher income levels. For no child phase-out begins at $13,930 and ends at $20600; for one child the limits are $23,930 and $45,207; for two children the limits are $23,930 and $50597 while for three or more children the phase-out ends at $53,930 with the other figures remains the same as for two children.
This write up is no substitute for legal or valid advice on the matter. This is an attempt at explaining the federal tax brackets in general terms.
