As part of the TAX CUTS AND JOBS ACT OF 2017, the IRS made temporary changes to the individual tax rates beginning in 2018. There was talk of decreasing the number of brackets, but the new law keeps the number of brackets the same at seven.
What you’re going to find is that in 2018, the tax brackets range from 10 percent up to 37 percent. In that range there are seven different brackets that people are going to hit (last year the range was 10 percent to 39.6 percent).
The top bracket went down by approximately 2.6 percent (most brackets went down between 2 and 4 percent).
So, explain to me how tax brackets actually work.
This is an area that has a lot of misconceptions. I hear people say that they do not want to make any more money because it will push them into a higher tax bracket! Although that may be true, not all of their income is taxed at the higher bracket. Only the portion of their income in that particular bracket gets taxed at that rate.
Can you give me an example?
Sure. Let’s say a married couple has taxable income of $80,000. They are essentially in the 22 percent tax bracket for 2018. The 22 percent bracket is actually the third bracket on the scale of the 7 tax brackets.
Of the $80,000, the first $19,050 of their income is taxed at 10 percent: The first bracket. So whether you make a million dollars or $80,000, that first $19,050 is always taxed at 10 percent. The next $58,350 of their income is taxed at 12% – the second bracket. Therefore, you are only paying the 12 percent for the next $58,350 of income. After adding those amounts together, that leaves $2,600 of their income that hasn’t been taxed yet. Therefore, just that portion is to be taxed at the 22 percent tax bracket rate.
So the entire $80,000 is not taxed at 22 percent?
Correct. In my example, only that $2,600 amount is taxed at the 22 percent rate.
Can people expect to get larger tax refunds due to this change?
Probably not. What happened is that the IRS put out new payroll tables that were implemented by employers around February 15, 2018. So around February 15, 2018, you may have noticed that your withholding went down a little bit and that is because of these new tables. These new tables reduced the amount of your federal withholding on your paychecks. These tables actually gave you the refund or the tax savings earlier than if you would have filed your return. What the IRS wanted to do was to give the refunds or tax savings to people as soon as possible, rather than waiting for early 2019 when tax returns were filed. Doing this out of withholding is the perfect way to do that. If they didn’t adjust the payroll tables, then you would get larger refunds, but you wouldn’t see that savings until probably early 2019 when you actually file your taxes. Therefore, if everything works as expected, the refund for the 2018 year should be similar to 2017.
Is there anything people should do to make sure their new withholding amount is correct?
I would go to the IRS website, IRS.gov, or search for the IRS withholding calculator. This is a good tool to determine what your withholding rate should be. If it is different than your current withholding, talk to your employer about filing a new Form W-4.