Understanding How Tax Brackets Work

Have you ever heard someone say that getting a raise would bump them into a higher tax bracket? This statement reflects a somewhat misguided conception about how tack brackets and their corresponding tax rates work. In the U.S., the tax system is progressive, meaning taxpayers are taxed at progressively higher rates in relation to their income. However, many Americans assume the entirety of their income is taxed at the rate in the highest tax bracket they fall into. However, this is not the case. In fact, a taxpayers’ income is divided into several brackets and therefore, is taxed at a variety of “marginal” rates. Here’s a look at how tax brackets and rates work in a progressive tax system.

Understanding How Tax Brackets Work in the U.S.

Tax brackets refer to a range of incomes that are subjected to a corresponding income tax rate. For example, the second bracket for single filers ranges from $9,876 to $40,125 in taxable income with the corresponding tax rate set at 12%. In the U.S., tax brackets result in a progressive tax system, in which a individual’s taxes increase in correspondence with their income. Individuals who make low salaries fall into brackets with low income tax rates while those with higher salaries fall into brackets with higher rates.

One of the most common misconceptions in the American tax system is that the entirety of a person’s income is taxed at the rate in the highest bracket they fall into. However, this higher percentage only applies to a certain portion of your taxable income.

For example, an individual who makes $37,000 will not have all of their income taxed at the rate of the highest bracket they fall into—or 12%. Instead, the first $9,876 of their income will be taxed at the rate of the lowest bracket–or 10%—and the remainder of their income will be taxed at 12%. The rate you owe on a certain range of your income is referred to as the marginal tax rate, as it only applies to your income within a certain margin. Currently, the IRS has established 7 tax income brackets, with marginal rates ranging from 10% to 37%.

Understanding the Marginal Tax Rate

The IRS tax brackets are divided into 7 marginal rates : 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The brackets you fall into will depend on your total taxable income, which can be affected by your filing status and the deductions you are eligible for.

Marginal tax rates mean you do not pay a fixed income tax rate on your entire income. Instead, portions of your income will fall into different tax brackets, and you’ll pay the bracket’s marginal tax rate on the amount of income that falls into the bracket’s income range. In short, this means your first dollar is taxed at the lowest tax rate while your last dollar is taxed at the rate of the highest bracket it falls within. All of the income in between is taxed at the rate for the range it falls into.

Understanding the Effective Tax Rate

Your effective tax rate is the actual percentage of your income you owe to the IRS. This rate will roughly reflect an average of the marginal rates you paid in different brackets. You can calculate your effective tax rate by dividing your tax bill by your gross annual income. For example, if your gross income was $125,000 and you paid $35,000 in taxes, your effective tax rate would be 28%. Your effective tax rate will almost always be lower than the rate on the highest tax bracket you fall into.

Choose Morgan Sebastian for Help With Your Taxes

At Morgan Sebastian Law, Attorney Becky Sebastian is eager to help you navigate the complexities of your taxes. As a trusted tax resolution lawyer, Attorney Becky Sebastian has years of experience representing business owners and individuals who are experiencing tax audits, wage garnishment, and other tax-related issues. She can provide you with the professionalism and peace of mind you deserve when dealing with the IRS.

To schedule a consultation with an experienced tax resolution lawyer, call (877) 223-6605 or fill out our online contact form.