Tax brackets are something that most people are somewhat familiar with but do not fully understand.
While it may not be the most interesting topic, understanding your tax brackets can result in a significant improvement in your income.
Whether you’re a freelancer navigating the difficulties of fluctuating income, a full-time employee wanting to maximize your salary, or someone planning for major life events like purchasing a home or retiring, understanding your tax bracket can be a game changer.
Enable to Make Informed Decision
The amount of income tax you pay is decided by your earnings, which are divided into several tax brackets.
Understanding your tax bracket is the foundation of any effective tax strategy.
Why?
Because understanding where you stand enables you to make informed decisions regarding deductions, allowances, and even how to timing your income.
Enables You to Plan Your Deductions and Credits
Knowing your tax bracket allows you to make the most of numerous deductions and credits.
For example, if you’re about to enter a higher tax band, you might want to raise your retirement account contributions to reduce your taxable income.
Reduce Deduction
If you have any influence over when you get income, such as freelancing payments or bonuses, knowing your tax bracket can help you time them effectively. For example, if getting a year-end bonus would push you into a higher tax band, you could choose to delay it until the next tax year. This type of planning can make a significant difference in reducing the deductions that will be claimed from you in your tax returns.
Investment Decisions
Your tax bracket may additionally impact investment choices. Various types of income, such as long-term capital gains and eligible dividends, may be taxed differently based on your tax bracket. Knowing where you stand allows you to make tax-effective investing decisions and make the most of your incoming funds.
How the Tax System Works for Multiple Income Streams
If you have many streams of income, you should be aware that they are all taxed together rather than separately. The IRS determines your tax bracket based on the total amount of income you received throughout the tax year.
So, if you make $75,000 from your salary job but also receive $25,000 in pension or other income each year, you will move up a tax bracket. You will then earn a total of $100,000 per year. You can use the same method to calculate how much tax you will owe on all of your income.
In Summary
Knowing your tax band is a key component of financial literacy. It influences how much you pay in taxes, affects your financial decisions, and assists you in planning to reduce your tax bill.
By taking the effort to understand and plan around your tax rate, you may make better financial decisions and improve your entire financial situation.
Are you prepared to take command of your financial future? Contact EBOS Cloud Accountants to learn about your tax bracket and how it affects your budget.
