Reducing Your Tax Rate

Although you can't literally lower your tax rate, there are certain actions you can take that will have a similar result. For example, you can shift income from a high-tax-bracket taxpayer (such as yourself) to a lower-bracket taxpayer (such as your child), perhaps by making one or more of your children a part-owner of your business, so that net profits of the business are shared among a larger group.

Warning The tax laws limit the usefulness of this strategy for shifting unearned income to children under age 19 (23 if dependent full-time student), but some tax-saving opportunities still exist. One fairly simple way to shift income to a child is by hiring your children to work in your business.

You could lower your effective tax rate by structuring an investment or transaction so that payments that you receive are classified as capital gains. Long-term capital gains earned by noncorporate taxpayers are generally lower tax rates than other income. However, this strategy is somewhat less attractive beginning in 2013, due to a new 3.8 percent tax imposed on net investment income and a higher long-term capital gains rate. Choosing the optimum form of organization for your business (such as sole proprietorship, partnership, or corporation can also provide opportunities for overall tax savings. The conventional wisdom is that sole proprietorships or pass-through entities (partnerships, LLCs, S corporations) usually offer more tax benefits, but with the individual rates slated to increase, the regular corporation could prove to be more tax-advantaged going forward for some business owners.

Tax Bracket Defined. When we say "tax bracket," we're referring to the highest federal tax rate that you pay on any of your taxable income. This is the rate that will apply to each additional dollar that you earn, until you earn so much that you graduate to the next bracket. You need to know your current tax bracket in order to make wise tax planning decisions, since many decisions will make sense for those in certain brackets, but not for those in others.

For 2013, there are seven tax brackets for individuals:

• 10 percent,
• 15 percent,
• 25 percent,
• 28 percent,
• 33 percent,
• 35 percent, and
• 39.6 percent.

For 2012, there were only six tax brackets for individuals (10 through 35 percent, above). The new 39.6 percent bracket is added for 2013.

Filing status determines bracket amounts. The dollar amounts at which each bracket begins is different for each filing status (that is, whether you file as single, head of household, married filing jointly, or married filing separately) and are adjusted for inflation each year.

Financial Calculators Knowing your income tax rate can help you calculate your tax liability for unexpected income, retirement planning or investment income. Use this Marginal and Effective Tax Rates Calculator to help estimate your effective (or average) tax rate, your current tax bracket, and your marginal tax rate. Press the view report button for a more detailed look at how we calculate your tax rates and what they mean to you.

The following chart shows the income thresholds at which each tax bracket begins for 2013. Note that the dollar amount does not refer to your gross income, but rather, your taxable income --that is, the income that is left after you've subtracted any deductions and personal exemptions to which you're entitled.