The Zero-Percent Tax Bracket

Have you ever heard about a 0% tax bracket? 

It does exist – although not officially.

Here’s the deal. If you look up the federal income tax brackets and tax rates online for 2021, you may find a table that looks something like this:

2021 Federal Income Tax Brackets and Rates for Single Filers, Married Couples Filing Jointly, and Heads of Households

Rate For Single Individuals For Married Individuals Filing Joint Returns For Heads of Households
10% Up to $9,950 Up to $19,900 Up to $14,200
12% $9,951 to $40,525 $19,901 to $81,050 $14,201 to $54,200
22% $40,526 to $86,375 $81,051 to $172,750 $54,201 to $86,350
24% $86,376 to $164,925 $172,751 to $329,850 $86,351 to $164,900
32% $164,926 to $209,425 $329,851 to $418,850 $164,901 to $209,400
35% $209,426 to $523,600 $418,851 to $628,300 $209,401 to $523,600
37% $523,601 or more $628,301 or more $523,601 or more
Source: Internal Revenue Service

You’ll see a 10 percent bracket, then a 12, a 22, and so on, all the way up to 37 percent for those whose taxable income is above five or six hundred thousand dollars, depending on their filing status.

So the first 20 grand or so of taxable income for a joint return is taxed at a 10 percent rate, then the next chunk, $61,000 of income, is taxed at 12 percent, and on up.  Once your taxable income is calculated, a tax rate is applied to each of those dollars.

Now remember, “taxable” income is less than your total gross income, because not all of your income is taxed.

Look at it this way: You have your gross income, then you have your adjusted gross income, then you have your taxable income below that.  But right in between the adjusted gross income and the taxable income, there is one of two things — either a standard deduction, or itemized deductions.  And you get to reduce your adjusted gross income by that standard or itemized amount.

In other words, that chunk of income is yours to keep, tax free.  Technically speaking, although it doesn’t exist officially, that income falls in a zero-percent tax bracket.

Here’s an example

Let’s take a hypothetical married couple with $100,000 of gross income.  We’ll keep it simple – they have no 401k, no other deductions anywhere, it’s just $100,000 of adjusted gross income for the year.  They went online, found the tax table that is showed above, and ran the calculations – 10 percent on the first approximately 20 grand, 12 percent on the next 61 grand, and 22 percent on the last 19 grand or so.  Add it all up, and they figure their tax bill is just shy of $13,500 on $100,000 of income – a 13.5% overall rate.

But their calculations in this case would be wrong.  Why?  Because our hypothetical couple is allowed to deduct just over $25,000 this year and take that amount of income tax free – a zero percent rate.  They should have figured the tax on $75,000 of “Taxable”  income – the 100 grand minus the 25,000 standard deduction.  By the way, if you’re 65 or older, you get an even larger deduction.

When you run those numbers, their tax bill is considerably lower: roughly $8,600 – NOT 13-five.  This is because with $75,000 of taxable income, none of it falls in the 22 percent bracket, and it even gives you a little bit of room left in the 12!

At that point, with about $5,000 of room left in the 12 percent bracket, you may want to consider removing some money from your 401k or traditional, taxable IRA.  Sure, you’ll pay taxes on it, but you’ll have to pay taxes on it eventually anyway, and unless you think tax rates will be lower in the future, that 12 percent rate might look pretty good.  Your advisor can help you with your options.

In the end… 

The point here is that it can be a really good idea to use the tax brackets to your advantage whenever you can.  If you’ve got a tax-free opportunity – take it.  Or if you’re in a window of time where you can pay lower taxes now than you will in the future, use it.  

Tax management is one of the things we do every single day here at Lucia Capital Group.  It’s all part of the planning process.  If you want to know more about how a tax-management strategy may benefit you, just give us a call.  We’re here to help!  Just give us a call – we’re here to help.

Important Information:

The information provided should not be considered specific tax, legal, or investment advice and is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.

Different types of investments and/or investment strategies involve varying levels of risk, and there can be no assurance that any specific investment or investment strategy (including the investments purchased and/or investment strategies devised by Lucia Capital Group (“LCG”)) will be either suitable or profitable for a client's or prospective client's portfolio, thus, investments may result in a loss of principal. Accordingly, no client or prospective client should assume that the presentation (or any component thereof) serves as the receipt of, or a substitute for, personalized advice from LCG or from any other investment professional.

You should always seek counsel of the appropriate advisor prior to making any investment decision. All investments are subject to risk including the loss of principal. This material was gathered from sources believed to be reliable, however, its accuracy cannot be guaranteed.

IRA withdrawals will be taxed at ordinary income rates. Withdrawals prior to age 59½ may also be subject to a 10% penalty tax.

Examples cited are hypothetical, are for illustrative purposes only, are not guaranteed and subject to potential federal and state law amendments. There is no guarantee that you will achieve the results discussed or illustrated.

Rick Plum is a registered representative with, and securities and advisory services offered through LPL Financial, a registered investment advisor and member FINRA/SIPC. The investment professionals are affiliated with LPL Financial and are conducting business using the name Lucia Capital Group, a separate entity from LPL Financial.

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