Tax and Financial Illiteracy Are Costing Americans

Paperwork is hardly anyone’s favorite activity, and it’s common for people to feel uncomfortable with math. Every year, though, millions of Americans face a task that requires both: filing taxes.

But insufficient tax and financial knowledge can lead to serious consequences for taxpayers. Most often this means failing to claim benefits that could reduce their tax liability or claiming benefits they aren’t eligible for, which could lead to an unexpected auditA tax audit is when the Internal Revenue Service (IRS) conducts a formal investigation of financial information to verify an individual or corporation has accurately reported and paid their taxes. Selection can be at random, or due to unusual deductions or income reported on a tax return. .

According to the National Financial Educators Council, financial illiteracy cost Americans more than $243 billion in 2024 alone—roughly $1,015 per person. Taxes play a key, yet often overlooked, role in financial literacy. In fact, the IRS Taxpayer Advocate declared tax literacy to be its top issue of the year in a 2024 report to Congress.

With the April 15^th deadline to file your 2024 tax return (or for an extension) fast approaching, and Financial Literacy Month underway, it’s important to understand basic tax concepts and how they relate to tax filing.

Improving Tax Literacy

Last year, TaxEDU and the Tax Foundation’s Center for Federal Tax Policy conducted the National Tax Literacy Poll examining American taxpayers’ basic knowledge and opinions on income tax filing. Among the poll’s noteworthy findings was that over 61 percent of US taxpayers did not know, or were not sure of, basic tax concepts related to filing income taxes. In addition, more than half were reportedly unfamiliar with how tax bracketsA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat. work.

These findings are alarming. If someone is not familiar with a basic concept like tax brackets and marginal tax rates, they may make serious financial missteps like forgoing a promotion or overtime for fear of losing money from a higher tax rate. But that’s not how it works!

Not all of your income is subject to your highest marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. . If your income places you in, say, the 22 percent bracket, then just the amount that falls within that bracket is taxed at 22 percent. The income within the first bracket is taxed at that rate, the amount within the next bracket at the next rate, and so on until you reach your top marginal rate.

TaxEDU’s How Do Tax Brackets Work? video provides a helpful breakdown of tax brackets and how they operate.

Many taxpayers may also be unaware that tax brackets change from year to year due to inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. , or as a consequence of changes to the tax code, adding an additional layer of complexity.

Preparing for the Future

The better we understand taxes, the better we can manage our finances, but it starts with familiarizing ourselves with basic tax concepts like how tax brackets work. Financial Literacy Month and tax filing season offer a great opportunity to become a bit more familiar with the tax code, and TaxEDU is here to help.

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