Prakash Kolli, Wealth of Geeks
It’s nearing the end of 2023, and the Internal Revenue Service (IRS) just announced the new income tax brackets for 2024, allowing people to plan ahead for their 2025 filings.
The IRS updates the seven income tax brackets annually, changing their ranges to account for inflation. They also raised the standard deduction and made other modifications based on laws passed by Congress.
Besides the income tax brackets, the dividend tax brackets, 401(k) and other retirement plan contributions, the Health Savings Account (HSA) limits, the Flexible Spending Account (FSA) maximums, and other items have changed.
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The new income tax brackets
The income tax brackets were bumped upward by 5.4%, lower than last year’s 7% increase but still more than typical.
The IRS annually changes the brackets using a formula based on the consumer price index (CPI) to address the effects of inflation. The changes also prevent taxpayers from entering a higher bracket and being taxed more without any actual increase in buying power. A scenario like this can occur when incomes climb at a rate less than inflation.
Seven brackets were established in 2017 by the Tax Cuts and Job Act. In America, federal taxation is progressive, meaning a higher income results in a greater percentage of taxation. The rates are 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
The brackets are summarized below for individual single taxpayers.
• 37% for incomes more than $609,350
• 35% for incomes more than $243,725
• 32% for incomes more than $191,950
• 24% for incomes more than $100,525
• 22% for incomes more than $47,150
• 12% for incomes more than $11,600
• 10% for incomes of $11,600 or less
Brackets for married couples filing jointly.
• 37% for incomes more than $731,200
• 35% for incomes more than $487,450
• 32% for incomes more than $383,900
• 24% for incomes more than $201,050
• 22% for incomes more than $94,300
• 12% for incomes more than $23,200
• 10% for incomes of $23,200 or less
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Marginal tax rate
A common myth about the tax brackets is the entire income is subject to the highest tax bracket, but that’s incorrect. Each tax rate is applied to income within a specific bracket.
For example, if a single person earns $50,000 annually, the first $11,600 is taxed at 10%. After that, the 12% rate is valid until $47,150. The remainder of the salary is taxed at 22%. As a result, the effective or marginal tax rate is lower.
Ross Dugas, Ph.D., of Scientific Financial, says, “It is important to note that the marginal tax rate isn’t applied to your entire income, only the portion within that bracket. An understanding of marginal tax rates will help you reduce lifetime taxes and understand when pre-tax and post-tax investments are more efficient.”
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Dividend tax brackets change, too
Because the income tax brackets indexed higher, dividend tax brackets climbed, too. However, unlike income tax rates, only three rates exist for qualified dividends: 0%, 15%, and 20%. Most taxpayers will pay 0% or 15%. The rates for unqualified dividends are the same as ordinary income.
The brackets are summarized below for individual single taxpayers.
• 0% for incomes up to $47,025
• 15% for incomes more than $47,025
• 20% for incomes more than $518,900
Brackets for married couples filing jointly.
• 0% for incomes up to $94,050
• 15% for incomes more than $94,050
• 20% for incomes more than $583,750
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Standard deduction was raised
In addition, for married couples filing jointly, the standard deduction was increased by 5.4% to $29,200, making it more attractive than itemizing for many people. The amount is $1,500 higher than in 2023. But individual single taxpayers only receive a $14,500 deduction, $750 more than this year.
Ross Blount, CFP, CRPC of Springbok Wealth Partners, told Dividend Power, “The standard deduction is generally better for most people than itemizing deductions. This is because the standard deduction is higher than the itemized deductions for most taxpayers. However, if you have a lot of deductible expenses, it may be better to itemize your deductions.”
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Retirement plan contribution limits are higher
The IRS usually raises retirement plan contribution limits each year, too. For 2024, 401(k) participants can contribute no more than $23,000, up by $500 for 2023. Similarly, most 403(b) and 457 plans are capped at $23,000. Additionally, annual contributions to an Individual Retirement Account (IRA) are now $7,000 in 2024, more than the $6,500 this year.
Pre-tax contributions to a regular 401(k) are a method to lower current taxes because they are tax-deferred until withdrawals are made. A Roth 401(k)’s contributions are made with after-tax dollars, and the gains grow tax-free. The differences between the two should be researched and discussed with a financial advisor before making decisions.
Likewise, a traditional IRA is built up with pre-tax money compared to a Roth IRA. Whether a Roth or Traditional IRA is better depends on a person’s financial situation, and it is often best to consult a financial professional.
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Higher HSA and FSA Maximums
The HSA and FSA programs help Americans manage and pay for health care expenses. In 2024, the maximum amount for both was incrementally indexed higher.
An HSA is beneficial for workers with high-deductible healthcare plans. To take advantage of an HSA, the individual deductible must be at least $2,800, which is an increase of $150 from 2023, but less than $4,150, up $200. At the same time, the family deductible must be between $5,550 and $8,350, higher by $200 and $450, respectively.
Workers contribute to an FSA by deducting pre-tax dollars from their paychecks. The limit rose $150 to $3,200 in 2024.
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The new tax brackets and the bottom line
The annual inflation adjustment keeps taxpayers from losing buying power by increasing income tax brackets and other categories. The past two years saw a sizeable increase of 7%, followed by 5.4%. Besides the above, there are changes to the Earned Income Tax Credit, Alternative Minimum Tax, estate tax exemption, Child Tax Credit, and gift tax exclusion. Taxpayers should check the IRS announcement for all the details.
