- Days left

Income Tax Rates: The More You Know, the Less You Pay

×
Tax on income
Alamy
One thing you may have noticed in preparing your tax return is that different types of income don't all get taxed at the same rate. Knowing how much tax you'll pay on each kind of income will help you figure out the best way to cut your tax bill this year and beyond.

Ordinary Income
For most income, the set of tax brackets ranging from 10 percent to 39.6 percent apply in calculating your total taxes. That includes not only wages and salaries but also business income, money you make from property rental, and most interest payments you receive.

In addition, some dividend income gets treated as ordinary income. And if you sell investments at a profit during the first year you own them, short-term capital gains get taxed at ordinary income rates.

In general, ordinary income rates are the highest you can pay, and qualifying for lower rates makes sense whenever possible.

Tax-Free Income
The ideal tax rate is zero, and a few investments provide tax-free income. The most common are municipal bonds issued by state and local governments, which produce interest that's free of tax.

But some investment vehicles actually transform what would otherwise be taxable into tax-free income. Roth IRAs make all the interest, dividends, and capital gains free of tax when you take money out during retirement, while 529 plans do the same for money used for educational purposes.

Dividends and Long-Term Capital Gains
Certain dividends qualify for a preferential tax rate. For top-bracket taxpayers, that rate is 20 percent. But those in the lowest two tax brackets pay nothing in taxes on qualified dividends, while those in between pay 15 percent.

The same treatment applies for most long-term capital gains. If you sell an investment at a profit after having held it for longer than a year, then the gains from the sale get taxed at the same rates as qualified dividends as described above.

Income From Sales of Collectibles
Profits from selling collectibles, such as coins, stamps, and precious-metals bullion, don't qualify for the low long-term capital gains rates above. Instead, a special 28 percent maximum rate is imposed on collectibles gains. If your ordinary tax rate is less than that, though, you'll pay the lower rate.

Know Your Taxes
By realizing that various types of income get taxed differently, you can tailor your investing strategy to take advantage of favorable rates and reduce your tax bill accordingly. That could make next April's tax bill look a lot better than what you pay this year.

More tax tips from DailyFinance:
5 Simple Rules for Keeping Your Tax Bill in Check
Last-Minute Tax Filing Tips
Don't Get Burned by Your Charitable Donations
The Most-Overlooked Tax Deductions

Increase your money and finance knowledge from home

How much house can I afford

Home buying 101, evaluating one of your most important financial decisions.

View Course »

Getting out of debt

Everyone hates debt. Get out of it.

View Course »

TurboTax Articles

What is IRS Form 8824: Like-Kind Exchange

Ordinarily, when you sell something for more than what you paid to get it, you have a capital gain; when you sell it for less than what you paid, you have a capital loss. Both can affect your taxes. But if you immediately buy a similar property to replace the one you sold, the tax code calls that a "like-kind exchange," and it lets you delay some or all of the tax effects. The Internal Revenue Service (IRS) uses Form 8824 for like-kind exchanges.

What are ABLE Accounts? Tax Benefits Explained

Achieving a Better Life Experience (ABLE) accounts allow the families of disabled young people to set aside money for their care in a way that earns special tax benefits. ABLE accounts work much like the so-called 529 accounts that families can use to save money for education; in fact, an ABLE account is really a special kind of 529.

What is IRS Form 8829: Expenses for Business Use of Your Home

One of the many benefits of working at home is that you can deduct legitimate expenses from your taxes. The downside is that since home office tax deductions are so easily abused, the Internal Revenue Service (IRS) tends to scrutinize them more closely than other parts of your tax return. However, if you are able to substantiate your home office deductions, you shouldn't be afraid to claim them. IRS Form 8829 helps you determine what you can and cannot claim.

What is IRS Form 8859: Carryforward of D.C. First-Time Homebuyer Credit

Form 8859 is a tax form that will never be used by the majority of taxpayers. However, if you live in the District of Columbia (D.C.), it could be the key to saving thousands of dollars on your taxes. While many first-time home purchasers in D.C. are entitled to a federal tax credit, Form 8859 calculates the amount of carry-forward credit you can use in future years, not the amount of your initial tax credit.

What is IRS Form 8379: Injured Spouse Allocation

The Internal Revenue Service (IRS) has the power to seize income tax refunds when a taxpayer owes certain debts, such as unpaid taxes or overdue child support. Sometimes, a married couple's joint tax refund will be seized because of a debt for which only one spouse is responsible. When that happens, the other spouse is said to be "injured" and can file Form 8379 to get at least some of the refund.

Add a Comment

*0 / 3000 Character Maximum

5 Comments

Filter by:
Roger Baack

Why is my social security income taxed again, as this is what was taken from my checks in the first place to create my social security income. It seems like double taxation to me.

April 11 2013 at 10:16 AM Report abuse +1 rate up rate down Reply
1 reply to Roger Baack's comment
chapython

From a federal level, if all you have or receive is Social Security, you will not pay a tax on it. Since by definition it is income, something you receive, many states do tax it as income but usually at a lower rate.

If you have additional earnings, part of your social security income may be taxed. For information, read your letter at the end of the year from social security administration.

April 11 2013 at 1:07 PM Report abuse rate up rate down Reply
nonucantmakemee

wasn't there a huge war over this a couple of hundred years ago?

April 11 2013 at 1:35 AM Report abuse rate up rate down Reply
scottee

I know that congress can change the tax RATE to 100% but unless they scrap the 73,000 pages of tax CODE, nothing changes.
I know that congress chooses power via the tax code over raising revenue.

April 09 2013 at 8:26 PM Report abuse -2 rate up rate down Reply
tmoschetti

"What to Know About Tax Rates"

That rarely does raising tax rates actually increases tax revenues, and often, as with the millionaire's taxes in NY and Md., the "luxury" tax, and the recent tax hike on the wealty in the UK!

Liberals simply are incapable of understanding that we don't live in a static world. Higher taxes almost always means lower revenues, because people change their behavior. That's why we have so many tax attornies and tax accountants.

April 09 2013 at 2:07 PM Report abuse rate up rate down Reply