For many Americans, there may not be a more unpleasant five-letter word than "taxes," and given that it's January, it's time for roughly 150 million adults to start thinking about preparing their taxes for the 2016 calendar year.
Tax time is generally no fun. According to a recent estimate from the tax authority itself, the Internal Revenue Service, taxpayers will spent 8.9 billion hours complying with federal taxes during 2016, or the equivalent of nearly 13,000 lifetimes. Yet we as taxpayers soldier on because, for many of us, there's a pot of gold at the end of the rainbow in the form of a federal refund. Although a refund isn't necessarily optimal because it means you've lent the government money, without interest, for a period of months or even over a year, a majority of taxpayers do wind up receiving money back from Uncle Sam.
America's most common tax bracket
Of course, what we wind up paying in taxes comes down to what ordinary income tax bracket we fall into. The higher your income, oftentimes the more you'll owe the IRS, assuming you don't have a bevy of tax credits and deductions to fall back onto.
As we head into 2017, the income tax schedule for taxpayers has seven brackets, ranging from a low ordinary tax rate of 10% to a peak ordinary tax rate of 39.6%. Here you can see how the income ranges shake out for the various types of filing statuses:
Data source: IRS. Table by author.
But have you ever wondered which tax bracket out of these seven, assuming you have taxable income, is the most common? Well, wonder no more. Thanks to IRS data from 2013, and a little aggregation from the Tax Foundation, we can answer that question.
Data source: IRS, Tax Foundation. Chart by author.
Nearly 42.2 million taxpayers had a peak marginal tax bracket of 15% in 2013, meaning (based on the income ranges from 2013) the most popular tax range had single individuals with adjusted gross incomes of between $8,925 and $36,250, or joint filers between $17,850 and $72,500.
What might be surprising is that the often left out 0% tax bracket came in a very close second, with nearly 36.9 million tax filers. These individuals and joint filers were able to get their income down to zero thanks to tax credits and deductions. In particular, the Earned Income Tax Credit is a valuable tool for lower-income working Americans, and it's easily the most overlooked credit. The IRS estimates that roughly 25% of taxpayers eligible for the EITC fail to claim it, either because the rules are too complicated, or they're unaware they qualify because they have zero taxable income and fail to file a tax return.
In total, 77% of American households, per the Tax Foundation, fall into the 15% tax bracket or lower, yet, according to the Tax Policy Center, the top 20% of income earners are responsible for paying 69% of all federal income taxes.
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Trump could shake things up
However, big changes could be waiting in the wings for taxpayers in the coming months. As Donald Trump readies to take the Oval Office, taxpayers prepare for what could be a major shakeup to the seven-bracket tax schedule.
According to Trump's campaign website, he plans to simplify the current tax schedule to just three brackets, as shown below:
Data source: Donald Trump campaign website. Table by author.
One of the more interesting aspects of this tax proposal is that it was revised in August 2016 to the 12%/25%/33% proposal we see now from Trump's original four-tier approach of 0%/10%/20%/25%. Why the change? Trump is eager to see individual income taxes cut for a majority of Americans, so he adopted the 12%/25%/33%, three-tier proposal offered previously by House Republicans. If the president and House are on the same page, it's simply a matter of getting the Senate on board to enact individual income tax reform. This still doesn't guarantee that reforms are coming, but it presumably improves the chances of tax reforms passing.
Furthermore, Trump has plans to do away with the laundry list of exemptions taxpayers currently enjoy. With the exception of the mortgage interest deduction and charitable giving deduction, Trump would essentially eliminate itemized deductions and simply fatten the standard deduction in return. In 2017, the standard deduction for single filers and joint filers is $6,350 and $12,700, respectively. If Trump gets his way, the standard deduction for single filers would vault to $15,000, and it would leap to $30,000 for joint filers.
If everything were to more or less remain equal to the data released from the IRS in 2013, roughly three-quarters of all taxpayers, if not more, would fall into the lowest tier (12%) under Trump's proposal.
All working Americans should be paying close attention to the tax discussion likely to come out Washington in the next few months as it'll undoubtedly have a bearing on your wallet.
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Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.