If so, this guide will help you.  Here, we look at everything you need to know to answer the question ‘what are tax brackets?’  Keep reading to learn more.

Introduction to tax brackets

Like many other countries, the United States uses a progressive tax system.  This means that different portions of your income are taxed at different rates.  In general terms, you’ll pay a higher overall tax rate if your income is higher.

Each income tax bracket means you pay a different tax rate on that portion of your income.

Tax brackets are the physical representation of this system and they show you how much you have to pay at different income levels.  For example, in 2011 and if you are single the lowest tax rate of 10% is applied to the first $8,500 of your income.  The next portion of your income is then taxed at 15%, and so on, up to the top of your taxable income.

The current tax brackets

Tax brackets and tax rates regularly change.  So, you should always check to see if you are using accurate tables when you file your taxes.

The tax brackets in 2011 depend on your filing status as follows:

Your ‘effective’ tax rate

The chances are that you will pay different tax rates on different parts of your income.  For example, if you have a taxable income of $100,000 you’ll pay four different rates of tax on different parts of your income.

The actual percentage of your income that goes to the IRS is often referred to as your ‘effective’ tax rate.  What you’ll therefore find is that the rate you pay on the last dollar you earn is usually much higher than your effective tax rate.

For example, if half of your income is taxed at 10 per cent and the other half at 15 per cent, your effective tax rate is 12.5 per cent.  This means that 12.5 cents of every dollar you earned this year goes to the IRS, although your ‘marginal’ tax rate (the rate paid on the last dollar of income you earn) is higher (at 15%).

Remember that any taxes that you pay are based on your taxable income.  This is your adjusted income after you have taken deductions and adjustments into account.

Keep in mind however that you don’t necessarily pay tax on all your income at the same rate.  Keep reading to learn more.

2010 tax brackets

The tax brackets in 2010 depend on your filing status as follows:

The ‘marginal’ tax rate

The US tax system is ‘progressive’, meaning that the amount of income taxes you pay increases in steps as your income increases

For example, if you had a taxable income of $80,000 in 2010 you won’t simply owe 25 per cent of all your income ($20,000) to the IRS.

In 2010, if you are a single taxpayer your tax would have been worked out as follows:

• The first $8,375 is taxed at 10 per cent ($837.50)
• The next $25,625 is taxed at 15 per cent ($3,843.75)
• The final $46,000 is taxed at 25 per cent ($11,500)

So, your total tax bill would be $16,181.25 as your tax is charged at different rates.

This also means that your ‘real’ or ‘effective’ tax rate on the $80,000 is 20.2 percent even though your marginal tax rate, which is the rate applied to the last dollar of income that you earned, is 25 per cent.

It is also important to keep in mind that this example also uses your gross earnings (in this case $80,000).  In reality you would be able to reduce this final taxable amount through deductions, adjustments and exemptions.  This will have the effect of reducing your income to a lower taxable level.

So, when filing your tax return it’s important that you work out what tax you owe based on the current tax brackets.  Our guide looks at the 2011 tax brackets and also contains a guide to working out what tax you owe.

2011 tax brackets

The tax brackets in 2011 depend on your filing status as follows:

 Working out what tax you pay

If you are trying to calculate your taxes due, there are two important factors to remember.

Firstly, any taxes that you pay are based on your taxable income.  This is your adjusted income after you have taken deductions and adjustments into account.

Secondly, you may pay tax at several different rates.  For example, if you are a single person and you have taxable income of $200,000, you do not pay all of your tax at the rate of 33%.  You will pay some at 10%, some at 15%, some at 25%, some at 28% and some at 33%.  You only pay 33% tax on the portion of your income over $174,401 ($25,600).

In this example – assuming taxable income of $200,000 – your tax bill would be worked out as follows:

• The first $8,500 is taxed at 10 per cent ($850)
• The next $26,000 is taxed at 15 per cent ($3,900)
• The next $49,100 is taxed at 25 per cent ($12,275)
• The next $90,800 is taxed at 28% ($25,424)
• The final $25,600 is taxed at 33% ($8,448)

Your total tax bill would be $50,897 NOT simply 33% of $200,000 ($66,000).

A tax deduction is an amount that you are allowed to subtract from your taxable income.  When you reduce your taxable income you reduce the tax you have to pay.  If your taxable income is $50,000 and you claim $10,000 in tax deductions, you’ll only pay tax on $40,000.  That will save you a considerable sum.  Keep reading to find out more about tax deductions.

Standard deduction vs itemized deductions

There are two ways you can file your tax return.  You can itemize deductions or you can take a standard deduction.

The standard deduction is a fixed amount of deductions based on your tax filing status.  It generally changes from year to year.  Itemizing simply means that you list each deduction on a separate Schedule A form which is submitted with your tax return.

Itemized deductions include:

1. Interest you paid for a home mortgage, including points and mortgage insurance premiums
2. Medical expenses
3. Charitable gifts to qualified organizations
4. Dental expenses
5. Job expenses not reimbursed by your employer
6. Tax preparation fees
7. Safe deposit box fees

You choose the option which is most beneficial.  For example, if you’re a single taxpayer, your standard deduction in 2011 is $5,800.  If you have more than $5,800 in itemized deductions, you should use this option as you’ll save more money.

Taking the standard deduction is easy because you don’t have to gather any records or do any calculations. However, this won’t help you reduce your tax bill.  You should always work out both ways and pick the method that lowers your taxable income the most.

You should remember that some of the deductions are limited based on your income. For example, you can only deduct the amount of your medical and dental expenses that exceed 7.5% of your adjusted gross income.  You’ll find the rules that apply in each case on your Schedule A form.

Tax Deductions You Can Take Without Itemizing

There are also some tax deductions you can take when you claim the standard deduction.  They’re listed on Form 1040 in the section labeled Adjusted Gross Income. They include the following:

Moving expenses if you’re moving over 50 miles for a new job
IRA contributions up to a maximum level
Health Savings Account contributions up to a maximum level when you have a high-deductible health plan
Alimony you paid
Student loan interest up to a certain level
Tuition fees paid to a qualified institution up to a certain level
Some self employed expenses such as health insurance payments

This guide should help you know if you can save money using either the standard deduction or itemized deductions.  Remember that the key is to work out your deductions using both methods and apply the one that reduces your tax liability the most.

If so, you’ll probably need to know what the 2011 tax brackets are.  The brackets change every year based on the rate of inflation and determine what amount of tax you actually pay.

Keep in mind however that you don’t necessarily pay tax on all your income at the same rate.  Keep reading to learn more.

2011 tax brackets

The tax brackets in 2011 depend on your filing status as follows:

The ‘marginal’ tax rate

The US tax system is ‘progressive’, meaning that the amount of income taxes you pay increases in steps as your income increases

For example, if you made $60,000 in 2011 you won’t simply owe 25 per cent of all your income ($15,000) to the IRS.

In 2011, if you are a single taxpayer your tax would have been worked out as follows:

• The first $8,500 is taxed at 10 per cent ($850)
• The next $26,000 is taxed at 15 per cent ($3,900)
• The final $25,500 is taxed at 25 per cent ($6,375)

So, your total tax bill would be $11,125 as your tax is charged at different rates.

This also means that your ‘real’ or ‘effective’ tax rate on the $60,000 is 18.54 percent even though your marginal tax rate, which is the rate applied to the last dollar of income that you earned, is 25 per cent.

It is also important to keep in mind that this example also uses your gross earnings.  In reality you would be able to reduce this final taxable amount through deductions, adjustments and exemptions.  This will have the effect of reducing your income to a lower taxable level.

However, you don’t have to have read the whole document or be a tax specialist to avoid some of the most common mistakes that people make when filing their tax returns.  Avoiding common mistakes might speed up your refund check or make the completion of your tax return more straightforward.

So, keep reading for three common tax mistakes you should avoid.

Filing Late

Doing your taxes can be an annual headache, but meeting the April 15 deadline is crucial.  If you don’t, you could face interest and penalty charges.

The IRS reports than one in five Americans leaves their tax return to the last minute by filing in the final week before the deadline.  If you have a complicated tax return, this may also mean you are more likely to make mistakes as the stress of sending your return increases as the deadline draws near.

If you wait until after the deadline to file your return you will be charged interest on any tax that you owe (compounded daily) at the federal short-term rate plus 3 per cent.  You’ll also face a penalty for filing late equivalent to 5 per cent of the amount owed for each month or partial month the payment is late, to a maximum of 25 per cent.

Not Keeping Up To Date with Tax News

While you’re not expected to know about every change to the 70,000 page Tax Code, keeping up to date with the major changes can be beneficial.

Keeping up to date with tax news can help you claim additional tax credits or benefits.  For example, the IRS posts the latest news for individuals affected by natural disasters as well as information about the latest tax scams.

Using the ‘latest news’ section of the IRS website is therefore recommended in order that you keep up to date with all the latest changes and any credits or rebates you may be eligible for.

Filing The Wrong Forms

When you complete an individual tax return you have the choice of three forms; the 1040, 1040A and 1040EZ.

While the IRS encourages all filers to complete the simplest form, it is important that you don’t pay too much tax just to benefit from an easier filing process.

For example, the 1040 is the most complicated form to complete but does allow you to itemize deductions.  This can result in significant tax savings if you claim the correct tax credits and deductions.

Conversely, the 1040EZ is fairly easy to complete but is only appropriate if you have a simple tax situation (for example no student loan interest or IRA contributions to write off).

Don’t complete an easier form just to save a bit of time; you could end up paying more tax than you need to.

But, what is Free File?  And how does it work?  Keep reading to find out.

What is Free File?

The IRS defines Free File as ‘a free, federal income tax prep and electronic filing program for eligible taxpayers’.

Free File has been developed through a partnership between the IRS and the Free File Alliance who are a group of private tax software companies.  You can submit your federal income tax return using the commercial software provided by these Free File Alliance companies but you must go to the IRS website to access the software.

Who is eligible for Free File?

The Free File program is open to you if you are a taxpayer with an Adjusted Gross Income of $58,000 or less.

Each of the participating software companies sets its own eligibility requirements and not all taxpayers will qualify for all companies.  Individual company offers may be limited by location or AGI so it’s important to review the criteria before you choose. The IRS also offers a “Help Me Select a Company” tool to help you find a Free File tax software program that meets your needs.

What does the $58,000 AGI limit apply to?

The AGI limit of $58,000 applies to individuals and to you if your filing status is ‘married filing jointly’.  The $58,000 applies to the total income of you both combined.

What is an electronic signature?

When you file a tax return online you have to electronically ‘sign’ your federal income tax return.  You do this with either the previous year’s AGI or with an electronic Personal Identification Number (PIN).  The PIN is a five digit number that you choose yourself and it is easy to obtain.

Do I have to download software?

No. All of the tax software will remain on the Free File company website and your return is filed from there.  All Free File company sites have the latest security encryption programs to protect your privacy.

Our guide looks at three of the most common home and property tax deductions.

Interest payments

Do you have a mortgage on your home?  If so, it is probably ‘fully amortized’.  This means that part of your monthly repayment goes towards repaying the debt while another part pays the interest.  This means that your mortgage will reduce as you make payments and your mortgage will be repaid at the end of the specified term.

If you itemize your deductions using Schedule A, the interest part of your mortgage payment is usually tax deductible as long as your primary residence or a second home is collateral for the loan (a ‘home’ can be a condominium, house, trailer, apartment, co-op or houseboat).

At the end of each year, your lender should send you a form 1098. This tells you how much you paid in interest and points during the year. This is your deductible interest (providing certain conditions are met).

If you obtained the loan prior to October 13, 1987, the loan is considered ‘grandfathered’.   All interest paid on grandfathered loans in a given year is fully tax deductible.

Home Acquisition Debt

‘Home acquisition debt’ is an IRS term for any first or second mortgage used to buy, build, or improve your home.  It can be a first or second mortgage used to buy your home. Alternatively, if you get a second mortgage and use it all for home improvements, that is also considered acquisition debt.

If you do a ‘rate and term’ refinance and don’t get any cash out – since you are just refinancing your acquisition debt – that also can be considered acquisition debt.

For any of the above loans that aren’t ‘grandfathered’ (see above) you can deduct the interest as long as your mortgage debt is less than $1 million ($500,000 each for married couples filing separately).

Home Equity Debt

Home equity debt is another IRS term and means any loan amount in excess of what was spent to purchase, build, or improve your home.

If you get cash out when you refinance your home, the amount in excess of your original loan amount is considered home equity debt (unless some of it was used for home improvement).  Anything in excess of the home improvement cost is considered home equity debt.

This works the same way for second mortgages in that anything not used to improve the home is considered home equity debt.

For the interest to be fully deductible, home equity debt cannot exceed $100,000.  In addition, the total mortgage debt on the home must not exceed its value.

This can be a problem if you have used a 125% loan-to-value second mortgages to consolidate debt. The portion of the loan amount that exceeds the value of your home is not tax deductible (unless you used it for home improvement).

Child Tax Credit reduces the amount of tax which you have to pay and our simple guide looks at everything you need to know about Child Tax Credit.

What is Child Tax Credit?

Tax credits reduce the amount of tax for which you are liable.  Whilst tax deductions reduce the amount of your income that is subject to tax, tax credits directly reduce your tax liability.

The Child Tax Credit is a non-refundable tax credit for people who have a ‘qualifying child’ (see below).

What counts as a ‘qualifying child’?

In order to claim Child Tax Credit, you must have a ‘qualifying child’.  A ‘qualifying child’ can include a child, foster child, descendant, stepchild, sibling, step-sibling or a descendant of any of these.

Additionally, in order to be a ‘qualifying child’ all the following must apply:

• The child must be under the age of 17 at the end of the current tax year
• The child must have lived with you for over half of the current tax year
• The child is a US citizen, US national or resident of the US
• The child provided less than half of their own support in the current tax year

A child is considered to have lived with you if the child was born or died in the current tax year and lived with you for the entire time he or she was alive.  If the child was away temporarily – at school, in medical care, in a juvenile detention facility or was serving with the military – then this counts as time living with you.

Limits to the amount of child tax credit you can receive

Child Tax Credit is limited to $1,000 per qualifying child.

In order to claim Child Tax Credit, you must have tax liability on line 46 of Form 1040, line 28 of Form 1040A, or line 43 of Form 1040NR.  The amount of Child Tax Credit cannot be more than your tax liability.  So, if the amount of credit is more than the tax you owe, you must reduce the amount of Child Tax Credit to no more than your tax liability.

If your modified adjusted gross income exceeds $110,000 for married filing jointly, $75,000 for single, head of household, or qualifying widow(er), or $55,000 for married filing separately, the amount of Child Tax Credit you can claim is reduced.

The amount of your standard deduction can change from year to year and our guide explains everything you need to know.  Keep reading to learn more.

The Standard Deduction

The amount of standard deduction that you can claim depends on your filing status.  There is a different dollar amount depending on whether your filing status is:

• Single or married filing separately
• Married filing jointly or Qualifying widow(er) with dependent child
• Head of household

In the 2011 tax year, the standard deduction amounts are:

• $5,800 – Single
• $11,600 – Married filing jointly
• $5,800 – Married filing separately
• $8,500 – Head of household
• $11,600 – Qualifying widow(er)

Higher Standard Deduction

If you are a taxpayer aged 65 or over, if you are blind (or both) than you can claim an additional standard deduction.

The additional amount based on your age will be granted if you or your spouse are aged 65 or over on the last day of the tax year.

The additional amount for blindness will be granted if you or your spouse are totally or partially blind on the last day of the tax year.  Partial blindness requires a certified statement from an eye doctor declaring that your field of vision is not more than 20 degrees or that you cannot see better than 20/200 vision on one eye even with glasses/contact lenses.

Additions to the Standard Deduction

There are also occasions when you can claim an additional standard deduction.  For example, you can claim a net loss from a federally declared disaster.

The Reduced Standard Deduction

There are occasions where you will receive a lower standard deduction.

For example, if another person can claim you as a dependent on their tax return, the amount of your standard deduction is reduced.  In this case, the amount of the standard deduction is generally restricted to $950 or your earned income for the year plus $300 (whichever is the greater).  The amount of the standard deduction for someone who is a dependent cannot, however, be higher than the regular standard deduction amount.

When you can’t claim the Standard Deduction

There are various times when you can’t claim the standard deduction.  These include:

• If you are claiming itemized deductions
• If you are married, your filing status is ‘married filing separately’ and your spouse is itemizing deductions
• If you have changed your annual accounting period and you are filing a return for a period of less than 12 months
• If you are a dual status or non resident alien during any part of the current tax year

As you cannot take both itemized deductions and a standard deduction, you will generally benefit by choosing the deduction that results in the lesser amount of tax that you owe.