Avoid Bumping Your Income into a Higher Tax Bracket
What can you do to avoid paying higher tax rates when you have a year with more income?
If your income level fluctuates from year to year, you may find yourself paying more than you expect at tax time.
That’s because when you have higher income, your income may be bumped into another tax bracket, causing you to pay higher tax rates at upper levels of income.
The tax rate jumps as much as 5 percent from one level to the next — a significant amount when you’re planning your tax year.
The following chart shows the income tax rates you pay at different income levels, based on your filing status.
Federal Income Tax Brackets, 2022 Tax Year (Source: IRS Publication 505)
| Tax rate | Single filers | Married filing jointly or qualifying widow(er) | Married filing separately | Head of household |
|---|---|---|---|---|
| 10% | Up to $10,225 | Up to $20,550 | Up to $10,275 | Up to $14,650 |
| 12% | $10,276 to $41,775 | $20,551 to $83,550 | $10,276 to $41,775 | $14,651 to $55,900 |
| 22% | $41,776 to $89,075 | $83,551 to $178,150 | $41,776 to $89,075 | $55,901 to $89,050 |
| 24% | $89,076 to $170,050 | $178,151 to $340,100 | $89,076 to $170,050 | $89,051 to $170,050 |
| 32% | $170,051 to $215,950 | $340,101 to $431,900 | $170,051 to $215,950 | $170,051 to $215,950 |
| 35% | $215,951 to $539,900 | $431,901 to $647,850 | $215,951 to $323,925 | $215,951 to $539,900 |
| 37% | Over $539,900 | Over $647,850 | Over $332,925 | Over $539,900 |
Find out which IRS tax bracket you are in. Estimate your tax year 2021 and 2022 tax rates here.
You can’t always fight getting into a higher tax bracket — nor would you want to.
The only way to consistently stay in the bottom 10 percent tax bracket as a single person, for example, is to have $10,225 or less in taxable income (after deductions and exemptions).
It’s better to make more money, even if that means paying a bit more in taxes.
If your taxable income is much higher in some years, however, you may be paying more income tax than you would if your income were spread out more evenly over the years.
Those years with a spike in income may cost you plenty in higher income taxes.
Most strategies for avoiding higher income tax brackets are based on moving income and deductions to even out your taxable income over a period of years or to avoid paying tax on some income until you retire.
Don’t forget to consider state tax, if you live or work in a state with income tax.
Consider these five ways to avoid spiking into a higher tax bracket this year:
1. Contribute to retirement plans.
Putting money into your traditional IRA, 401(k) plan, or other retirement plan reduces your income now, when you may be in a higher tax bracket.
Sure, you pay tax on the money when you take it out in retirement. If you’re in a lower tax bracket after you retire, however, you’ll pay far less income tax that way.
For example, say you are in the 24 percent tax bracket now, while you are working.
You contribute to a traditional retirement plan, reducing your taxable income this year by the deductible amount.
When you withdraw the money after retirement, you may be in a 12 percent or 22 percent tax bracket — a significant improvement tax-wise.
2. Avoid selling too many assets in one year.
Say you have a stock that’s gone up in a short period of time. You’d like to sell it and cash in on those gains.
Consider selling some of the shares in one year, and some the next, if selling the stock would put you in a higher tax bracket.
If you’ve held a capital asset, such as stock, for more than one year, you may qualify for long-term capital gains rates, which are even lower.
3. Plan the timing of income and business expenses.
If you’re self-employed, you have some control over when you get paid and when you make expenditures.
Using the cash method of accounting, for example, you claim revenue in the year you receive it, even if you did the work in the previous year.
If you have a banner year and need to buy equipment for your business, for example, you may want to make the purchase by the end of the year.
On the other hand, if you’ve had a slow year and you expect to be in a higher tax bracket next year, you may put off making business expenditures until January 1 or later.
You have some discretion over when you bill customers and get paid when you are self-employed as well.
4. Pay deductible expenses and make contributions in high-income years
Planning to make significant contributions to a charitable organization?
Make sure you write that check or put it on your credit card in the year you’re in the highest tax bracket.
A $100 contribution will save you $32 in federal income taxes when you are in the 32 percent tax bracket and already itemizing deductions.
If you make the same $100 contribution in a year when you’re in the 24 percent tax bracket, it only saves you $24 in federal income taxes.
You can also make sure you make your January mortgage payment by Dec. 31 if your income is higher this year.
Your January mortgage payment covers December interest expense, so you may as well pay it in December and take the mortgage interest deduction.
5. If you’re a farmer or fisherman, use income averaging
Some taxpayers are allowed to smooth their income out over a three-year period, using a process called “income averaging.”
This can help keep income spikes from pushing them into higher tax brackets.
Prior to 1987, all taxpayers could use income averaging. Now, you must be in a farming business or working as a fisherman to benefit from it.
What if you can’t avoid bumping into the next tax bracket when your income rises?
All else being equal, you’re still better off making more money and paying a slightly higher tax on it that you would be making less.
Don’t forget — the higher tax bracket only applies to your income that exceeds the last tax bracket limit.
To better understand how tax brackets work read this article.
Do you have a steady income level that keeps you in the same income tax bracket year after year, or does your income level vary significantly?
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