2022 tax updates and a refresh on how tax brackets work
The IRS recently announced increases to both the standard deduction and tax brackets for taxpayers in 2022. Are you aware of how an increase to the standard deduction and an increase to tax brackets will impact you?
As you know, there are many headlines leading up to anticipated tax code changes, a litany of speculations throughout the process, and a cacophony of opinions once official tax code changes are announced. To be succinct, these two 2022 tax changes will have a small but favorable impact on most households. Everyone’s tax situation differs, but we wrote this blog to break down the complexities of the latest tax code changes.
What has changed?
1. The standard deduction will increase for the 2022 tax year. See below for a summary of the increases:
2. Federal income tax brackets will increase 3% for the 2022 tax year compared to 2021. Including a visual of the 2021 federal tax brackets is TMI for this post, but below are the new 2022 tax brackets:
what does this mean for me? it may not be much.
The practical answer is that these 2022 updates are not expected to have a significant impact on your taxes, cash flow, or budget. Both increases are good news for most households, but not life changing. To show how the changes are applied, we included a fictitious example and illustration below.
The academic or technical answer is that the increase in standard deduction means households will have less income subject to taxes, and the income that is subject to taxes will be subject to better tax brackets.
To provide an example of the impact of the 2022 increased standard deduction and 2022 increased tax brackets, read on.
Meet MARTIN & ANGELA
Below is a breakdown of their taxable income and taxes due in 2021 compared to 2022.
As you can see, they reported $100,000 of combined income which is reduced by their pre-tax 401(k) contributions and the standard deduction. Specifically, the standard deduction for married filed jointly is changing from $25,100 to $25,900 in 2022 so their taxable income is less than it was in 2021. Less taxable income puts Martin and Angela on track to pay less federal tax in 2022 than in 2021.
PORTIONS OF YOUR INCOME GET TAXED AT DIFFERENT RATES
Tax brackets calculate the tax rate you will pay on each portion of income. Tax brackets are part of our progressive tax system, which means the tax rate increases as someone’s income grows. As shown on the second image of this blog, there are 7 different federal tax brackets in 2022.
Looking at the image above, you can see that you can split your taxable income to take advantage of the lowest tax bracket. Isn’t it true that Martin and Angela would prefer to have a portion of their income taxed at the 10% rate before moving into the 12% tax bracket? In 2021, the maximum income allowed at the lowest tax bracket of 10% was $19,900. In 2022, the maximum income allowed will be $20,550.
DRUMROLL, PLEASE…
After this exercise is completed for all their taxable income, you can see that their total taxes owed in 2021 is $7,990 compared to $7,881 in 2022. As illustrated above, Martin and Angela will pay $109 less federal taxes in 2022 than they did in 2021. This will be welcomed news, but not a life-changing update when compared to the amount of buzz these two tax changes will generate in the media.
If you have questions about your unique tax situation, please schedule a time to connect with our team. As always, we would love to hear from you!
Disclaimer: this post is for educational purposes and not predictive of your 2022 tax situation. The fictitious example is not a full presentation of a tax filing.
