Tax season is often a source of stress for many. Understanding how taxable income affects your tax amount due and potential refund is critical for effective financial planning. Many overlook this important aspect when preparing their taxes, which can lead to costly mistakes. This post aims to clarify taxable income and explain its impact on your tax obligations and refund opportunities.
What is Taxable Income?
Taxable income is the part of your income that is subject to taxation by the government. To get your taxable income, take your gross income and subtract any deductions, exemptions, and tax credits you qualify for. This figure is essential as it determines how much tax you owe or can expect to get back as a refund.
Taxable income includes various earnings such as wages, salaries, dividends, and interest. For instance, if you earn a salary of $60,000 and take standard deductions of about $13,850 (for single filers in 2023), your taxable income would drop to $46,150. This figure plays a crucial role in calculating your overall tax liability.
How Taxable Income Affects Your Tax Amount Due
Your tax amount due primarily relies on your taxable income. In countries with a progressive tax system, higher income brackets are taxed at higher rates. For example, in the U.S., the tax rate for 2024 ranges from 10% for the lowest bracket to 37%. If your taxable income falls into a lower bracket, you might pay a significantly lower tax rate compared to a higher-income earner.
Additionally, deductions and credits can lower your taxable income, which in turn reduces your tax payment. Common deductions include mortgage interest, which can account for thousands of dollars off your taxable income, and student loan interest, potentially reaching $2,500. Make sure to review all available deductions to manage your taxable income.
Determines Your Tax Bracket
Taxable income determines the tax bracket you're in, which affects the percentage of tax you owe on each portion of your income.  In the US, we use a progressive tax bracket system to figure the tax on our taxable income. Progressive tax brackets are a system of taxation designed to ensure that individuals with higher incomes pay a larger percentage of their income in taxes compared to those with lower incomes. This system is structured into various tiers or brackets, each corresponding to a specific range of income and a specific tax rate. As a taxpayer’s income increases, the rate at which their income is taxed also increases, but only for the income that falls within each bracket.
To illustrate how progressive tax brackets function, let’s break down the income ranges earned in 2024. In the U.S. tax system, income can be taxed at seven different rates.
10% Tax Rate: Income from $0 to $11,600 ($23,200 for married couples filing jointly).
12% Tax Rate: for incomes over $11,600 ($23,200 for married couples filing jointly).
22% Tax Rate: for incomes over $47,150 ($94,300 for married couples filing jointly).
24% Tax Rate: for incomes over $100,525 ($201,050 for married couples filing jointly).
32% Tax Rate: for incomes over $191,950 ($383,900 for married couples filing jointly).
35% Tax Rate: for incomes over $243,725 ($487,450 for married couples filing jointly).
37% Tax Rate: for individual single taxpayers with incomes greater than $609,350 ($731,200 for married couples filing jointly).
Impacts Eligibility for Tax Credits and Deductions
Many credits and deductions phase out as taxable income increases (e.g., Child Tax Credit or student loan interest deduction). Â
For example, a major tax credit that many taxpayers look forward to claiming every tax year is the Earned Income Tax Credit. This credit is available to low and middle income - earners. This credit phases out (or completely goes away) once your income gets too high. The IRS table below lists the maximum income levels for this credit for 2024. You will notice that once your income exceeds $59,899 (or $66,819 married filing jointly), this credit is no longer available to you.
(IRS Earned Income Tax Credit Table, irs.gov)
Affects Capital Gains Tax Rates
Short term capital gains are taxed as ordinary income. This means that the applicable tax rate (mentioned above) is the same tax rate that is applied to all other income, such W-2 income wages.
Long - term capital gains are taxed differently. Taxable income influences the rate at which long-term capital gains are taxed (0%, 15%, or 20%) as seen in the table below. Â
Determines Additional Taxes
Higher taxable income may trigger additional taxes, such as the Net Investment Income Tax (NIIT) or Medicare surtax.Â
The Net Investment Income Tax (NIIT)Â is an additional 3.8% tax applied to certain types of investment income for individuals, estates, and trusts that exceed specific income thresholds.
The Medicare Surtax, also called the Additional Medicare Tax, is an extra 0.9% tax applied to high earners on wages, self-employment income, and railroad retirement compensation that exceed certain thresholds. It was introduced as part of the Affordable Care Act (ACA) to help fund Medicare.
Influences State and Local Taxes
Many states use taxable income as a base for their tax calculations, which means changes to federal taxable income can impact state taxes.  Taxable income plays a significant role in determining the amount of state and local taxes (SALT) you owe. Many states and local governments base their tax rates and brackets on your federal or adjusted taxable income, but the specifics vary by jurisdiction.
Most states that levy income taxes use taxable income as the basis for calculating state income tax.
Progressive Tax Rates: States like California and New York have progressive tax systems, meaning that as your taxable income increases, you move into higher tax brackets and pay a higher percentage in taxes.
Example: A taxpayer earning $50,000 pays a lower rate than someone earning $500,000.
Flat Tax Rates: States like Colorado or Illinois impose a flat income tax rate, where all taxpayers pay the same percentage regardless of income. In these states, higher taxable income simply leads to a proportional increase in taxes.
No Income Tax States: States like Texas, Florida, and Washington do not impose income taxes, so taxable income has no direct impact on SALT for those states.
In summary, your taxable income isn’t merely a number; it plays a crucial role in shaping your financial future. Understanding its implications allows you to make smarter decisions and potentially secure larger refunds. Invest the time to educate yourself and plan, and watch how your financial situation improves.
Comments