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. These include:

• Shifting income from a high-tax-bracket taxpayer (such as yourself) to a lower-bracket taxpayer (such as your child). One fairly simple way to shift income to a child is by hiring your children or 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.

• 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 subject to lower tax rates than other income.
• Choosing the optimum form of organization for your business (such as sole proprietorship, partnership, or corporation). For example, the sole proprietorship or pass-through entities (partnerships, LLCs, S corporations) usually offer more tax benefits.

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.

In 2010 (and in 2011 and 2012), there continue to be six tax brackets for individuals: 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, and 35 percent.

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 2010. Note that the dollar amount does not refer to your gross income, but rather, your taxable income — that is, income after you've subtracted any deductions and personal exemptions to which you're entitled.