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Tax season is upon us! It’s time to start thinking about your income tax bracket for 2021, so you can get a jump on preparing your tax return for the internal revenue service. There will be seven federal income tax brackets in 2021, and the following guide will help you understand how they work. Using some of the top small business tax software can also make the task much more manageable.
What is a Tax Bracket?
A tax bracket is the range of income that is taxed at a certain rate, and it also largely determines how much money is withheld from your paycheck. The federal government decides which bracket applies to you by looking at your taxable income, which is your total income minus any deductions or credits you qualify for.
Federal income tax brackets are usually presented in tabular form, making it easy to see how they work at a glance. And once you figure out your filing status, single, married, head of household, etc., you can use them to determine your tax rate and taxable income the same way the government does when you file your taxes with the internal revenue service. You can also look at state tax websites for more information as well as small business tax deductions coming your way.
Income Tax Brackets 2021
The seven federal tax brackets for the 2021 tax year are 10%, 12%, 22%, 24%, 32%, 35% and 37%. Your income tax bracket corresponds with your taxable income and filing status, and below are the seven tax brackets based on the marginal tax rate for the tax year 2021. You can use the federal income tax brackets in the tables to calculate your tax bill and make your payment by the April 2022 deadline (or in October 2022 if you filed an extension).
Filing Separately
| Taxable income bracket range | Applicable Tax rate | Tax you need to pay |
|---|---|---|
| $0 - $9,950 | 0.1 | 10% of taxable income |
| $9,951 - $40,525 | 0.12 | $995 + 12% of the amount over $9,950 |
| $40,526 - $86,375 | 0.22 | $4,664 + 22% of the amount over $40,525 |
| $86,376 - $164,925 | 0.24 | $14,751 + 24% of the amount over $86,375 |
| $164,926 - $209,425 | 0.32 | $33,603 plus 32% of the amount over $164,925 |
| $209,426 - $523,600 | 0.35 | $47,843 + 35% of the amount over $209,425 |
| $523,601 or more | 0.37 | $157,804.25 + 37% of the amount over $523,600 |
Jointly Married Filing Separately
| Taxable income bracket range | Applicable Tax rate | Tax you need to pay |
|---|---|---|
| 10% | $0 - $9,950 | 10% of taxable income |
| 12% | $9,951 - $40,525 | $995 + 12% of the amount over $9,950 |
| 22% | $40,526 - $86,375 | $4,664 + 22% of the amount over $40,525 |
| 24% | $86,376 - $164,925 | $14,751 + 24% of the amount over $86,375 |
| 32% | $164,926 - $209,425 | $33,603 plus 32% of the amount over $164,925 |
| 35% | $209,426 - $314,150 | $47,843 + 35% of the amount over $209,425 |
| 37% | $314,151 or more | $157,804.25 + 37% of the amount over $523,600 |
Married Couples Filing Jointly
| Taxable income bracket range | Applicable Tax rate | Tax you need to pay |
|---|---|---|
| $0 - $19,900 | 10% | 10% of taxable income |
| $19,901 - $81,050 | 12% | $1,990 + 12% of the amount over $19,900 |
| $81,051 - $172,750 | 22% | $9,328 + 22% of the amount over $81,050 |
| $172,751 - $329,850 | 24% | $29,502 + 24% of the amount over $172,750 |
| $329,851 - $418,850 | 32% | $67,206 + 32% of the amount over $329,850 |
| $418,851 - $628,300 | 35% | $95,686 + 35% of the amount over $418,850 |
| $628,301 or more | 37% | $168,993.50 + 37% of the amount over $628,300 |
Head of Household Tax Brackets
| Taxable income bracket range | Applicable Tax rate | Tax you need to pay |
|---|---|---|
| $0 - $14,200 | 10% | 10% of taxable income |
| $14,201 - $54,200 | 12% | $1,420 + 12% of the amount over $14,200 |
| $54,201 - $86,350 | 22% | $6,220 + 22% of the amount over $54,200 |
| $86,351 - $164,900 | 24% | $13,293 + 24% of the amount over $86,350 |
| $164,901 - $209,400 | 32% | $32,145 + 32% of the amount over $164,900 |
| $209,401 - $523,600 | 35% | $46,385 + 35% of the amount over $209,400 |
| $523,601 or more | 37% | $156,355 + 37% of the amount over $523,600 |
Changes to Federal Income Tax Rates in 2021
The Internal Revenue Service updates tax rates, allowances, and thresholds annually. One change to the federal income tax rate for 2021 is the standard deduction amount, which has increased to account for inflation. The standard deduction is a fixed amount of income that is not taxed, and it reduces your taxable income to assist in lowering your federal tax bill.
Comparing the standard deduction rates for 2020 vs. 2021 in the table below, you can see that the amount has increased for all tax brackets. For taxpayers filing separately, the standard deduction is now $12,500 (up from $12,400 in 2020), for heads of households it’s $18,800 (up from $18,650), and for joint married filers it’s $25,100 (up from 24,800).
Standard Deductions 2020 vs. 2021
| Filing status | 2020 standard deduction amount | 2021 standard deduction amount |
|---|---|---|
| Filing Separately | $12,400 | $12,500 |
| Jointly Married Filing Separately | $12,400 | $12,550 |
| Married Couples Filing Jointly | $24,800 | $25,100 |
| Head of Household | $18,650 | $18,800 |
Other tax changes for 2021 affect tax filers with children and include increased child tax credits (CTC) and earned income credit. The tax credit’s maximum amount is now $3,000 for every child and $3,600 for kids under 6. Another change is that you can have no income and still claim CTC. The earned income credit for 2021 ranges from $1,502 to $6,728. Eligibility for it depends on your tax-filing status, income and how many children you have.
What is the Difference Between Federal Tax Brackets and Tax Rates?
Although they appear to be similar and are used to calculate the total income tax owed, tax brackets and tax rates differ. Here’s how: The tax rate is the percentage at which your income is taxed. On the other hand, a tax bracket has differing tax rates like 10%, 12%, or 32%, which is also known as the marginal rate.
How do Tax Brackets Work?
A tax bracket is the tax rate that you pay on the highest dollar of the taxable income you bring in. That doesn’t mean it’s the tax rate on all of your income after you figure in deductions, adjustments and exemptions, either. Instead, your tax bracket only determines your income tax rates for every additional dollar you make while ignoring rounding effects.
The United States has these types of tax brackets because we use a progressive tax system that is based on the concept that the higher-income tax filers can afford to pay more. So, in a progressive system, the higher your income, the higher the income tax rate you can expect to pay. Your income bracket reflects this, and your tax burden becomes progressively higher if you exceed the income thresholds that place you in the next tax level bracket.
In a nutshell, the marginal tax rate is the amount of additional tax you pay for every additional dollar you make, and it will correspond with the highest tax bracket you are facing.
Working Out Your Taxable Income
Now that you understand what tax brackets are, it’s time to learn how they work for your small business. Since most small businesses are charged at an individual income tax level, you can use the federal tax brackets for 2021 above for taxpayers filing separately.
First, however, you need to calculate your taxable income. A business is taxed on the profit it clears after all its allowable deductions are taken away from its revenues. It breaks down to the formula:
Revenues – Business Deductions = Total Taxable Income
Business Deductions
A business generally has two types of tax deductions that can be used to reduce its taxable income: Cost of goods sold and operating expenses.
- Cost of goods sold: A company’s cost of goods sold (COGS) is the total costs used to create its products and services. For example, if you make and sell jewelry, the cost of goods could be the cost of the material to make them and the wages of the manufacturers.
- Operating expenses: A business’s operating expenses are the costs it takes to keep the organization running. Examples could be things like advertising, interest, shipping, bank fees, accounting fees, office supplies, rent and utilities.
Calculating Tax Owed
You can see how to calculate your small business’ tax burden for 2021 by using the income tax bracket for filing separately. Here are two examples we’ve worked through for you to go by.
Example 1: Assume Small Business A makes $12,000, and the COGS and operating expenses were $5,050 combined. Revenue minus the business deductions will be $12,000 – $5050, making their taxable income $6,950. Referencing the table’s tax bracket for that amount, the tax Business A will need to pay is $6,950 x 10%, which is $695.
The next example shows how an example works when the marginal rate kicks in. With this rate, a person’s income isn’t taxed by a single rate and instead is taxed at multiple rates, and according to each tax bracket your income level falls in.
In addition, each tax rate is only applicable to income that falls within its corresponding marginal tax bracket. When that happens, every additional dollar beyond that bracket is taxed by utilizing the next highest marginal rate.
Example 2: Assume Small Business B makes $71,900. Say COGS and operating expenses were $43,000 combined. Therefore, revenue minus the business deductions will be $71,900 – $43,000, making their taxable income $28,900.
Referencing the table, Business B falls into the 12% marginal tax rate bracket. So, to determine the tax, it’s $995 plus 12% of the amount over $9,950.
To get the amount over $9,950, you subtract $9,950 from $28,900 and obtain $18,950. Multiply the result by 12% and add $995.
$18,950 X 12% = $2,274. That result + $995 = $3,269.
So tax owed with a taxable income of $28,900 is $3,269.
Tips to Get Your Business into a Lower Tax Bracket
Owning a business and turning a healthy profit can be sort of a catch-22 situation. On the one hand, you’re doing well and should be proud of your accomplishments. On the other hand, you now have to pay taxes on all that income.
Fortunately, there are ways to get your company into a lower tax bracket, so you pay less federal income taxes. This includes being aware of standard deduction for small business. Here are a few tips:
- Hire a financial professional or accountant: Even if you’re the only one working in your business, it’s important to get an adviser involved. A professional can help you identify more deductions that could lower taxes and then plan around them accordingly.
- Look into retirement planning: Retirement accounts like IRAs or 401Ks can be great ways for small businesses to save money on their tax bill each year.
- Keep good records: Stay on top of all income and expenses related to your business. This simple act will make tax time much easier and could save you money on penalties for not having proper documentation.
- Purchase assets: If you’re in the market for new equipment, consider buying it at the end of a tax year or the beginning of a new one. Doing this will allow your company to take advantage of depreciation and lower its taxable income even more.
- Time income and expenses strategically: Known as “accelerating expenses and deferring income,” this technique is a great way to get your company into the lower tax brackets. For example, let’s say you’re running an e-commerce site that sells its products at the end of each year. If you defer income until next year by delivering late or sending out invoices after January 31st, it will give more time for expenses like shipping and advertising to be deducted from this year’s taxable income.
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