New tax brackets protect you from inflation

Each year, the IRS employs what we can call a “Fair Play” approach when dealing with inflation. What it means is they know that inflation reduces the buying power of everyone’s earnings. Therefore, keeping the same tax brackets for years results in an unfair advantage on its part.

To remedy this situation, the IRS adjusts tax brackets every year to cater for inflation’s impact on your disposable income. Your disposable income is what you are left to spend after tax-related expenses and social security charges. So, if inflation rises, let’s say by 1% in 2021, it means that your money sheds off 1%, or more, of its buying power. I said ‘or more’ because some manufacturers and retailers will not stick to the 1% adjustment in line with inflation. They can increase their prices by more than that, and you will still have to buy your supplies from them.

Given the above, the IRS knows it’s not fair to keep you on lower minimum tax brackets when inflation increases each year. Raising tax brackets helps cushion you from the scourge of paying higher tax-related bills where prices of goods are rising.

I mentioned ‘lower minimum tax brackets’ above, and I feel I need to level with you here. I can explain this using an example. If the IRS says will apply the lowest tax rate of, say 5% to individuals earning at most $7,000; that is your minimum tax bracket for the year (between $0 and $7,000). Let’s say inflation rises by 1,5% this year. That would take away $105 from the taxpayer in question. But then, this person’s employer sees there is inflation and decides to increase their salary to, perhaps $7,500, slightly above inflation adjustment. If the IRS does not change its previous tax brackets, it means this taxpayer could be moved to the next higher tax rate, in the next tax bracket, maybe 10%. But it does not make sense because his real earnings (after applying inflation) would be far less than the 5% increase in taxes. As such, it only results in the person’s disposable income decreasing.

Therefore, when the IRS sets new tax brackets for the following year, they will consider this change. They will know that this taxpayer will lose something like $105 of his money to inflation. To be fair, they can increase the minimum tax bracket to, perhaps, $7,500. So, instead of being taxed in the unfair 10% tax rate, the individual in question will remain in the 5% tax rate. That way, the said salary increase wouldn’t be for nothing.

Here are the new tax brackets for 2021

Every year, the IRS makes around 40, or more, tax provisions for inflation. As mentioned, the IRS is guided by movements in inflation, as per the Chained Consumer Price Index (C-CPI). Adjusted together with income thresholds are also deduction amounts and credit values. And here is the summary of the 2021 Federal Income Tax Brackets and Rates.

Tax rates will range from 10% to 37%. The minimum rate of 10% applies to unmarried individuals that earn up to $9,950. Married couples earning up to $19,900 and household heads earning up to $14,200 will be taxed at the same rate.

2021 Federal Income Tax bracket for Unmarried Individuals

2021 Federal Income Tax Bracket for Married Individuals

2021 Federal Income Income TaxBracket for Heads of Households

A 2% difference separates the above tax bracket and the next. This means that unmarried individuals earning between $9,951 and $40,525 will be taxed at 12%. Married individuals filing joint returns and household heads for the same tax rate will be those with an income of $19,901 to $81,050 and $14,201 to $54,200, respectively.

Here is a summary of the rest of the tax brackets.

Individuals earning between $40,526 and $86,375 have a 22% tax rate. Jointly filing married couples earning between $81,051 and $172,750 and household heads earning between  $54,201 and $86,350 will also be taxed at 22%.

Individuals who earn between $86,376 and $164,925 have a tax rate of 24%. This also applies to jointly filing married couples who earn between $172,751 to $329,850 and heads of households earning between      $86,351 and $164,900.

At 32% are individuals with an income from $164,926 to $209,425, married couples earning from $329,851 to $418,850 and heads of households with an income between $164,901 and $209,400.

Individuals with an income from $209,426 to $523,600; married couples earning between $418,851 and $628,300; and married couples jointly filing their return, earning between $209,401 and $523,600 will all be taxed at 35%.

And finally, individuals, married joint filers and household heads with an income of over $523,600, $628,300 and $523,600, respectively, pay the highest tax rate of 37%.

More on changes from the IRS

The standard deduction for all groups we have been discussing will also increase. For 2021, individuals will see a $150 increase in the standard deduction. This also applies to married couples filing their return separately. But married joint filers and heads of households will see an increase of $300 and $150 respectively.

2021 Standard Deduction

2021 Alternative Minimum Tax Exemptions

2021 Alternative Minimum Tax Exemption Phaseout Thresholds

For 2021, there is no limitation on itemized deductions, according to the IRS. This was eliminated by the Tax Cuts and Jobs Act, as it applied in 2020, 2019 and 2018. And finally, these tax year 2021 adjustments described above generally apply to tax returns to be filed in 2022.