So you’re ready to learn how to calculate your own taxes? You need to know a few things first: your gross income, any adjustments and deductions you have, and any credits you qualify for. In this post, you’ll learn exactly how to calculate your AGI (adjusted gross income), your taxable in come, and your tax bill using a tax bracket table. This post is about calculating your tax bill NOT how to do your taxes. Doing your taxes involves filling out the form and you can do this through a software like Turbo Tax or taxact.com (I’ve used both).
Knowing how to calculate your taxes gives you ownership over this bill you have to pay every year. It is also the first step in being able to do advanced financial planning for yourself as taxes are always a consideration in any plan you make. By November, you want to be able to calculate your tax bill due the following April so you can make any adjustments you want or need. For example, you may choose to increase your 401(k) contributions for the rest of the year in order to reduce your tax bill because you earned a bonus.
Example 01: The Simplest Case
The most straightforward case a person could be is a single individual who doesn’t own a home and doesn’t contribute to any retirement plan. This person does not have any student loans and qualifies for no tax credits.
Assume Single Sam grossed $40,000 this year. Single Sam will take the standard deduction because he does not own a business or make charitable contributions. Sam has no reason to itemize his deductions. The Standard Deduction is worth $6350 for tax year 2017. Sam also qualifies for the Personal Exemption* which is worth $4050 in 2017. Sam will subtract these two values from his gross income.
Single Sam determines his taxable income to be $29,600. Now he will go to the IRS published tax bracket table to find where he falls.
|Rate||Taxable Income Bracket||Tax Owed|
|$0 to $9,325||10% of Taxable Income|
|$9,325 to $37,950||$932.50 plus 15% of the excess over $9,325|
|$37,950 to $91,900||$5,226.25 plus 25% of the excess over $37,950|
|$91,900 to $191,650||$18,713.75 plus 28% of the excess over $91,900|
|$191,650 to $416,700||$46,643.75 plus 33% of the excess over $191,650|
|$416,700 to $418,400||$120,910.25 plus 35% of the excess over $416,700|
|$418,400+||$121,505.25 plus 39.6% of the excess over $418,400|
Single Sam knows his taxable income of $29,600 places him in the second row in this table. That means he is in the 15% tax bracket. He sees he must pay $932.50 plus 15% of the excess over $9325. Sam needs to calculate the “excess” over $9325, so he splits his income into 2 parts: the $9325 and the excess.
For the $9325, Sam owes $932.50 in taxes. For the excess value of $20275, Sam owes 15% of that in taxes.
Sam just has to add those two tax values together to find his total federal tax bill for the year.
He finds that he owes $3973.75 which would round up to $3974.
An important thing to note is that Sam does not have to pay tax of 15% on his entire taxable income. This is a common misconception. He only pays 15% on the portion of his income that spills into the 15% bracket. If he had spilled into the 25% tax bracket, he would have to pay 25% only on the part of his income that was beyond $37,950, not all of it.
Example 02: A Real Millennial
Hopefully you are not Single Sam. If you are, you’re going to want to add some diversity to your financial plan and start saving for retirement. Single Sam is just there to show you how to use the tax bracket table. Now I am going to walk you through my tax bill calculation, which is a little more complex but still entirely doable.
Let’s gather all of my information first:
- Gross Income: $58,642.66
- $58533 income from work
- $32.48 in investment dividends
- $76.45 in earned interest on savings
- Adjustments: $12,155.50
- retirement contributions
- STRS pension (14%): $8194.86
- 403(b): $1800
- health care premium: $855
- educator expense deduction: $133.63
- student loan interest: $1172.01
- retirement contributions
- Deductions & Exemptions: $10,400
- Standard Deduction: $6350
- Personal Exemption $4050
- Credits: $70.72
- Lifetime Learning Credit: $70.72
- This credit allows for a person to subtract 20% of tuition payments for earning a degree or acquiring further job skills
- Lifetime Learning Credit: $70.72
First we begin with my gross income and subtract off all of the adjustments to income.
After subtracting off all of those adjustments, we arrive at the number labeled “Adjusted Gross Income.” I want to hold on to this number because it is needed when I file my state taxes. I don’t need to do anything more with it right now.
Now I am ready to subtract off my deductions and exemptions to find my taxable income.
I see my taxable income is $36,087.16. I will scroll back up to the tax bracket table that Single Sam was referencing. I find that I also belong in the second row, since my income is between $9,325 and $37,950. I am in the 15% tax bracket and I need to find my excess over $9325 to be able to calculate my total tax bill for 2017.
After breaking my income into the 10% and 15% brackets, I find my tax liability is $4946.80. But wait! I have that credit for Lifetime Learning. Since credits are dollar for dollar benefits, I get to subtract that value off this bill.
My federal tax bill for tax year 2017 is $4876.10. Since I paid in $6764.16 over the year through paycheck withholdings, I am due a refund.
My refund should be 1888.60 from the Federal government. Now, since the IRS likes whole numbers, I actually get just a tiny bit more than this. They round at various points in this calculation so my actual refund was $1890.00.
Thoughts on taxes
Since I know how to calculate my taxes, my next thought is “wow almost $5000 in taxes! That sure is a lot of money. Is there any way I can get out of that?” I don’t want to not pay my taxes, I just want to pay less. I think back to what helped me lower my tax bill to start with: adjustments, deductions, and credits. I could always earn less…. but then, I am earning less money. I don’t want to do that (even though $58k included a bonus I won’t get again). You might have noticed that Single Sam paid $903 less than I did in federal taxes, even though I made more than $18,000 more than he did. Adjustments, deductions, and credits really help lower your tax liability. I realize if I contribute more to my pre-tax retirement accounts I could lower my AGI which in turn lowers my tax bill. Now I am thinking I want to save more for retirement because there is a direct benefit to me now.
Many people are due a refund at tax time because they pay too much in over the course of the year. Remember that this is determined by the number of allowances you set for yourself. For 75% of the year, my allowances were set to 0 which is why I am getting a refund. Some people always want to get that refund. I took my refund and contributed it entirely into my Roth IRA last week. Setting yourself up to get a refund can be useful savings tool. Don’t set it so you’ll get a refund if you are going to spend the entire thing. Save at least 90% of it. If you’re bad at saving money, your tax refund can be a forced savings you only think about once per year. Just don’t do this if you always spend money as soon as it gets into your account.
After doing your federal taxes, you need to do your state taxes. That will be one of my next two articles, so stay tuned!
*Personal Exemptions are gone in the new tax bill so this calculation is not relevant for tax years beyond 2017.