What Are Tax Cuts?
Tax cuts are changes to tax law that effectively reduce the amount of tax you pay.
Key Takeaways
- Tax cuts are changes to the tax code that reduce the amount of tax you have to pay.
- A common way of cutting taxes is to reduce the income tax rate—the percentage of taxable income that an individual or business pays in taxes.
- Taxes are also cut when a change in the tax law expands the tax brackets so that a higher amount of income is subject to the same tax rates.
- Increasing the size of a deduction, or increasing the maximum income a person can earn to be eligible to claim a deduction, can cut taxes for taxpayers.
Changes to taxes
The term “tax cuts” can seem a little confusing because it's a broad term that covers a wide range of situations that result in a lower amount of tax collected by the government from one or more groups of taxpayers. The one thing all tax cuts have in common is that they change a preexisting tax law or implement a new one that effectively reduces the amount of tax you have to pay.
Cutting income tax rates
A common tax cut that the U.S. Congress and various state governments offer periodically is a reduction in the income tax rate. This is a very broad way of reducing income taxes since all affected taxpayers will benefit automatically.
As of 2024 for example, the lowest rate of tax the U.S. government charges you on ordinary income is 10 percent. If this changes next year to 8 percent, then Congress has issued a tax cut. To illustrate, suppose you file as single and have $8,000 of taxable income. Using the 10 percent rate, you will pay $800 of income tax. However, after this tax cut, you only pay $640.
Temporary tax cuts
In some cases, governments will cut taxes for a specific amount of time to stimulate the economy with the tax cut disappearing in the future.
A perfect example is the temporary reduction of the Social Security tax rate from 6.2 to 4.2 percent during the 2012 tax year. However, in 2013 and beyond, the rate returned to 6.2 percent. Similarly, in 2009 Congress allowed those receiving unemployment compensation to exclude the first $2,400 of it from taxable income. This exclusion is no longer available, and you have to report 100 percent of your unemployment compensation on your tax return.
TurboTax Tip:
Governments often cut taxes for a specific amount of time to stimulate the economy. As a result, tax cuts can be temporary.
Expanding tax brackets
Most governments that charge an income tax use a progressive system of taxation. That is, various income tax rates apply to specific ranges or brackets of income. Rather than employing a tax cut with a reduction in tax rates, a similar result occurs when the upper limit of income subject to the lower tax rates increases.
For example, during 2023 the IRS imposed tax at the rate of 10 percent on your first $11,000 of taxable income if you were filing single. For 2024 the range for the 10 percent bracket increases to your initial $11,600 of taxable income. This tax cut can save you a significant amount of money since less of your income is subject to tax in the higher brackets.
Increasing deduction limits
A majority of the deductions you claim have limitations in the amount you can deduct or the maximum income you can earn to be eligible to claim it.
For example, when you itemize deductions, you can include the portion of your total medical expenses that exceed 7.5 percent of your adjusted gross income (AGI) for 2024. However, if Congress ever decides to reduce this AGI limitation or eliminates it entirely, this is effectively a tax cut since the end result is that you pay less in taxes when you are able to claim a higher deduction.
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