Think You’ll Bump Up a Tax Bracket? Here’s What to Do

If you have a variable income and think you’ll zip up to another tax bracket or if you’ve made just that much more this year, you may end up paying a boatload at tax time. 

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It’s very easy to not take the time to understand how taxes work, particularly if you take all your documents to your accountant every year. 

However, a growing number of Americans prepare and file their own tax returns. For example, in 2020, over 71 million taxpayers prepared and e-filed their federal tax returns themselves by October 2020, according to the IRS.

Let’s walk through how to avoid going up a tax bracket in preparation for next April.

Tax Brackets, Explained

You could find yourself in one of seven tax brackets: 10%, 12%, 22%, 24%, 32%, 35% and 37%. Tax brackets apply to the tax rate you will pay on each portion of your income. For example, as a single individual, the lowest tax rate, 10%, applies to the first $9,950 of your income. The next chunk of your income gets taxed at 12%, and this keeps going, up to the top level of your taxable income. If you are married, filing jointly, you are married filing jointly, you and your spouse will stay in the 10% tax bracket until your income exceeds $19,900.

Ways to Level Off, not Level Up Your Tax Bracket

Experiencing a little anxiety as you see your income going up and up? Let’s take a look at a few ways you can exert a little control over your tax situation. 

Lean on Your Retirement Plans

Getting tax wise doesn’t always mean you have to jump through a lot of hoops — often it just involves putting money into a tax-advantaged retirement plan, such as a traditional IRA, 401(k) or another type of plan. When you use a traditional 401(k) or IRA, you pay tax on the money when you retire. However, this works to your advantage if you believe you’ll be in a lower tax bracket upon retirement. You can save yourself from paying a lot in income taxes this way.

In addition, money that gets pulled from your take-home pay and put into a 401(k) and this lowers your taxable income, meaning that you pay less during tax time. 

So, what might all of these rules look like in real life? Let’s say you are in the 32% tax bracket while you’re working. You put money away in your traditional 401(k) for years and years. When you’re ready to retire (or at least age 59 ½), let’s say you find yourself in the 25% tax bracket. You’ll pay taxes based on that income in that tax bracket.

Watch Those Short-Term Capital Gains

Try to hold on to your assets for longer. You’ll pay short-term capital gains tax when you sell an asset that you hold for one year or less, and this is almost always higher than long-term capital gains. You pay short-term capital gains tax based on your ordinary income tax bracket — 10%, 12%, 24%, 32%, 35% or 37%. 

Short-term capital gains:

 

Single Filers

Married Filing Jointly Filers

Married Filing Separately 

Head of Household

10%

$0 – $9,950

$0 – $19,900

$0 – $9,950

$0 – $14,200

12%

$9,951 – $40,525

$19,901 – $81,050

$9,951 – $40,525

$14,201 – $54,200

22%

$40,526 – $86,375

$81,051 – $172,750

$40,526 – $86,375

$54,201 – $86,350

24%

$86,376 – $164,925

$172,751 – $329,850

$86,376 – $164,925

$86,351 – $164,900

32%

$164,926 – $209,425

$329,851 – $418,850

$164,926 – $209,425

$164,901 – $209,400

35%

$209,426 – $523,600

$418,851 – $628,300

$209,426 – $314,150

$209,401 – $523,600

37%

$523,601+

$628,301+

$314,151+

$523,601+

Long-term capital gains tax is the rate you pay if you hold an asset for more than one year. You invariably get a break, particularly if you’re in the highest income tax brackets. Long-term capital gains look like this: 0%, 15% or 20% in 2021. Take a look at how long-term capital gains correspond to your long-term capital gains rate. 

Long-term capital gains:

Tax Rate

Tax Filing Status: Single

Tax Filing Status: Married

0%

$0 – $40,400

$0 – $80,800

15%

$40,401 – $445,850

$80,801 – $501,600

20%

$445,851+

$501,601+

Alternatively, you could consider selling some of the shares in one year, and some the next, if selling your assets would put you in a higher tax bracket.

Plan When You Pay Yourself

Consider when to make payments to increase expenses and tax deductions. You can also consider delaying the sending of late-in-the-year invoices so you don’t get payment until 2022. You may also want to buy things you need for your business instead of waiting till 2022. Let’s say you need new office furniture. You decide to buy it in December 2021 instead of waiting until January 2021. You might also send a customer a bill in December 2021 but not get payment until January 2022. 

Make Charitable Contributions

You must itemize to take a charitable deduction. If you itemize, it might add up to more than the standard deduction. The more you can deduct, the less you’ll pay in taxes. The total of itemized deductions may be more than the standard deduction. There are hundreds of possible deductions.

Americans are a charitable bunch, with a record $471 billion of their money going to charities in 2020, according to Giving USA. This was a 5.1% increase in total giving over 2019. 

If you know your income will push you into another tax bracket, giving money to charity can help keep you at a lower tax bracket.

You must itemize in order to take a charitable deduction. If you itemize, your total deductions are greater than the standard deduction. If they’re not, stick with the standard deduction. A few things to note: You can only deduct a charitable contribution in the year in which you make a payment. There are limits to how much you can deduct, but they are high. 

Use Income Averaging

Income averaging means that the IRS lets you spread out profits from your business over the three tax years that came before this one. The catch? Only fishermen or farmers can take advantage of it. 

Talk to an Accountant

Are these the only ways that you can manhandle your taxes to your advantage? Of course not. Getting an accountant on your side can give you access to several additional tips and tricks. Ask around among family members, friends and business associates for accountant suggestions in your area.

Know What to Do When Your Income Bumps Up

Think you’ll still zip into the next tax bracket when your income rises? Take heart, you’re still better off making more money and paying a slightly higher tax on it than making less money altogether.

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