In a surprising twist amid persistent inflation, there’s a silver lining: a larger portion of your income will face lower tax rates in the upcoming year.
The Internal Revenue Service (IRS) recently unveiled its annual adjustments to federal income-tax brackets for 2024. This adjustment, slightly outpacing the current inflation rate, carries the promise of reduced taxes for some Americans.
These adjustments, rooted in formulas outlined in the tax code, serve the purpose of preventing inflation from causing a surge in taxes. Noteworthy among these adjustments is the 5.4% increase in both the standard deduction and the thresholds for each tax bracket. This marks the second-largest adjustment in the past three decades, following last year’s substantial 7.1% hike.
Looking specifically at the top federal income-tax bracket for 2024, the threshold is set to climb by nearly $40,000 for a married couple. In the coming year, the 37% income-tax rate will be applicable to income exceeding $731,200, while for individuals, the top tax bracket commences at $609,350.
It’s essential to understand that your effective tax rate is lower than your top rate. This is due to the tiered structure of taxation, where the initial portion of income is taxed at 10%, the subsequent portion at 12%, and so forth. Consequently, your effective tax rate is essentially a blended rate.
Many individuals tend to equate their tax rate with their bracket. For instance, being in the 24% bracket does not translate to paying 24% on the entirety of their income. This nuance underscores the importance of comprehending both the tax brackets and your marginal tax rate.
Understanding these nuances becomes particularly crucial for effective year-end planning. To illustrate, consider a married couple with an income of $300,000, taking the standard deduction. In this scenario, they would have a marginal tax rate of 24%. Importantly, they would still have over $100,000 within that bracket before transitioning to the 32% rate.
This strategic understanding of the remaining portion within their current bracket can guide decisions about potential financial moves. For example, if they have little or no investment income, they might contemplate converting part of a traditional individual retirement account into a Roth IRA, also known as a Roth Conversion. This strategic move could secure the favorable 24% rate for the conversion, leveraging the remaining available space in their current tax bracket.
Therefore, while inflation may cast a shadow over economic considerations, the adjustments in federal income-tax brackets for 2024 bring a glimmer of relief for taxpayers. A nuanced understanding of these adjustments and their implications empowers individuals to make informed financial decisions, optimizing their tax liabilities and making the most of available opportunities.
Here at B&C Financial Advisors, we work closely with our clients and their CPAs/tax preparers when planning for the upcoming year. We provide valuable information regarding capital gains, investment income, IRA distributions, and more to ensure they are equipped to make informed decisions in pursuit of their overall financial goals.
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