How to Get the Biggest Tax Refund Possible

In part two of a three-part series on IRS tax brackets, Julian Block defines taxable income, busts a longstanding tax myth, and explains exactly what people who are in the top two brackets need to know before they file their 2020 taxes.

Feb 25th 2021
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Part one discussed seven graduated tax brackets for Form 1040s for calendar year 2021 that will be filed in 2022. It explained the first five brackets—10, 12, 22, 24 and 32 percent.

Part two discusses the top two IRS tax brackets—35 and 37 percent. First, though, let’s deconstruct “taxable income” (line 15 of the 1040 for calendar year 2020). The IRS precisely defines taxable income.

It’s the amount that remains after filers report income from such sources as wages, salaries and other kinds of employee compensation, such as severance arrangements; net earnings from self-employment ventures; pensions; distributions from IRAs, 401 (k)s, and other tax-deferred retirement accounts; and Social Security benefits.

Filers then offset what they report with write-offs authorized on the1040’s Schedule A for itemized deductions or for standard deduction amounts claimed by nonitemizers, along with all other allowable deductions, and before they claim any credits.

Scroll down several paragraphs for an example of how the IRS determines the tax tab for single filer Hilda whose income falls into four brackets—10, 12, 22 and 24 percent. First, though, let’s start with the two top brackets of 35 and 37 percent.

35 percent. Use the sixth of the seven brackets for taxable income between: $209,426 and $523,600 for singles; between $209,426 and $314,150 for marrieds filing separately; between $418,851 and $628,300 for married persons filing joint returns and qualifying widows/widowers (surviving spouses who qualify for the same breaks as married couples for two years after a spouse dies); and between $209,401 and $523,600 for heads of household.

37 percent. Use the seventh of the seven brackets for singles and heads of household with taxable incomes above $523,601; joint filers and surviving spouses with incomes above $628,301; and marrieds filing separately with incomes above $314,151.

A myth that refuses to die. Surveys continually disclose that most Americans mistakenly believe that something like this happens to, say, Hilda, a filer who’s single and who is in a top bracket of 24 percent. They believe that the law allows the IRS to siphon off 24 percent of the income that she reports on her 1040 form.

Actually, of course, the law allows the IRS to tax Hilda at that rate on only the part of her income that’s in her top bracket. What about the part of her income that falls into lower brackets? It’s taxed at those lower rates.

To illustrate, Hilda anticipates 2021’s taxable income will be $100,000. The IRS taxes the $100,000 in exquisitely precise slices: the brackets of 10 percent (the first $9,950 of her income); 12 percent (income between $9,951 and $40,525); and 22 percent (income between $40,526 and $86,375).

Finally, how much does the law allow the IRS to tax at a rate of 24 percent? Just $13,625 ($100,000 minus the $86,375 it already appropriated).

How does the IRS react when Hilda’s move to a higher-paying job causes her taxable income to exceed $164,925, the top number for the 24-percent rate? It requires her to move into the next bracket, where each added dollar of income is taxed at a 32-percent rate.

How does it react when a Corona-caused salary decrease drops her income below $86,376, the bottom number for the 24-percent rate? It okays her descent to the 22-percent bracket.

State income taxes. Hilda isn’t finished with numbers crunching when she’s liable for both federal and state income taxes. Is her combined top bracket simply the sum of her federal, state and city brackets?

Nope. It’s her top federal bracket, plus the state and city brackets, minus the federal tax savings that becomes available, assuming she’s able to claim local taxes as an itemized deduction on Schedule A of the 1040 form

But, there can be complications. One is that those local levies might not be fully deductible on Schedule A, because the Tax Cuts and Jobs Act imposes a cap of $10,000 on write-offs for state and local property taxes and income taxes. Another is that an adamant IRS insists that Hilda say sayonara to any write-offs if she decides it’s more advantageous to skip Schedule A and claim her standard deduction amount.

Stay tuned for part three, the final column. It’s a reminder for high-income individuals and their advisers. Accountants, financial planners and other advisers should alert clients to strategies that sidestep or minimize Medicare surtaxes.

True, official rates top out at 37 percent for clients who are recipients of ordinary income from sources like salaries and other types of compensation; pensions; and distributions from IRAs, 40l (k)s, and other tax-deferred retirement accounts. But their unofficial rates could go higher if they’re in top brackets above 22 percent.

Why? Because they might be liable for the Medicare surtaxes of 0.9 percent on earned income and 3.8 percent on investment income.

Additional articles. A reminder for accountants who would welcome advice on how to alert clients to tactics that trim taxes for this year and even give a head start for next year: Delve into the archive of my articles (more than 350 and counting). 

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