2 in 3 Americans Can’t Identify the Top Income Tax Rate

Taxes are a part of life for everyone — albeit a pretty unpleasant part. But it’s important to know how the U.S. tax code works on a basic level.

This isn’t to say that as an individual taxpayer, you’re expected to know every single rule. That’s a tough thing even for the professionals.

Rather, you should have a basic understanding of how income is taxed in this country, and what you can do to lower your IRS bill. But new data reveals that most Americans sorely lack key tax knowledge, and that’s a problem.

Do you really understand the tax code?

A recent survey by the Tax Foundation identified some serious knowledge gaps in the context of taxes. In fact, only about one-third of survey respondents were able to correctly identify the highest federal income tax bracket.

If you’re not sure what that is, it’s 37% for individual taxpayers with incomes greater than $626,350. But for married couples filing taxes jointly, that 37% rate applies to incomes above $751,600.

However, that doesn’t mean that if you’re single earning $627,000, that you’re going to pay 37% on your entire income. The U.S. tax system is a marginal one, which means that you pay a lower rate of tax on your lowest dollars of earnings and a higher rate of tax on your highest dollars of earnings.

Here’s a simplified example. Let’s say you’re single earning $20,000 a year. Your first $11,925 is subject to a 10% tax rate. Beyond $11,925, you move into the 12% tax bracket. But you’ll only be looking at a 12% tax rate on earnings beyond $11,925 — in this case, $8,075.

There are also steps you can take to reduce your taxable income and lower the amount of taxes you pay on a whole. Contributing funds to a traditional IRA or 401(k), for example, reduces your taxable income. And it could bump you into a lower tax bracket.

It pays to know the rules

Another thing the above survey revealed is that many Americans are misinformed about tax refunds. A good 28% agreed with the statement “Large tax refunds are a good thing.”

In reality, it’s not so great to get a large refund, because it means that you gave the government an interest-free loan when you could’ve been using or earning interest on that money yourself. An ideal situation is to get a very small refund or owe the IRS a very small amount of tax each year (getting it so you owe nothing or get nothing back is very difficult).

Americans are also confused about the difference between a tax credit and a tax deduction. A tax credit is a dollar-for-dollar reduction of your tax bill, while a deduction exempts some of your income from taxes. But the savings a tax deduction gives you will hinge on your tax rate.

Clearly, there’s a lot to learn about taxes. So your best bet is to seek help from a tax professional — and not just during tax season.

Sure, you could hire someone to file your tax return so you don’t get it wrong. But it’s also a good idea to sit down with a tax professional and have them identify ways for you to reduce your IRS burden on a long-term basis. Spending a little money for that advice could be one of the best investments you’ll ever make.