Ever heard anyone say that a raise would put them in a higher tax bracket. This statement is a misinterpretation of how tax brackets work and the corresponding tax rates. The U.S. tax system is progressive. This means that taxpayers are subject to progressively higher tax rates relative to their income. Many Americans believe that their entire income is subject to tax at the highest bracket in which they fall. This is incorrect. Actually, the income of taxpayers is broken into multiple brackets, and thus, taxed at various “marginal” rates. Let’s take a look at the tax brackets and rates in a progressive tax system.
Understanding How Tax Brackets Work In The U.S.
A tax bracket is a range in income that is subject to a specific income tax rate. The second bracket, for single filers, ranges in income from $9,876 up to $40,125 with the corresponding tax rate of 12%. The U.S. has a progressive tax system where tax brackets correspond to income. Individuals with lower salaries are placed in brackets that have low-income tax rates, while those with higher salaries are placed in brackets with higher rates.
The American tax system has a common misconception that all income is subject to tax at the highest bracket. This higher percentage applies only to a small portion of your taxable income.
An individual earning $37,000 per year will not be subject to the tax rate at which they are in the highest bracket, i.e. 12%. Instead, the first $98,876 of an individual’s income will be subject to the tax rate of the lowest bracket (or 10%), and the rest of their income at 12%. Because it applies only to income within a specific range, the marginal tax rate is the rate you owe. The IRS currently has 7 tax income brackets with marginal rates that range from 10% to 37%.
Understanding the Marginal Rate of Tax
The IRS tax brackets can be divided into seven marginal rates: 10%, 12%; 22%, 24%; 32%, 32%, 35% and 37%. Your total taxable income will determine which bracket you fall into. This can also be affected by how you file and what deductions you are allowed to claim.
Marginal tax rates are not fixed income tax rates. You will pay the bracket’s marginal rate for income that falls within the bracket’s income range. Instead, you will have portions of your income fall into different tax brackets. This means that your first dollar will be taxed according to the lowest tax rate, while your last dollar will be taxed according to the highest bracket it falls in. All income between the two is subject to tax at the applicable rate.
Understanding the Effective Tax Rate
The IRS will calculate your effective tax rate, which is the percentage of your income that you owe. This rate is a combination of marginal rates that you have paid in different brackets. Your gross annual income can be used to calculate your effective tax rate. If your annual gross income is $125,000, and you have paid $35,000 in taxes each year, your effective tax rate will be 28%. Your effective tax rate is almost always lower than the tax rate in the highest tax bracket that you are in.
This article was written by Alla Tenina. Alla is one of the best IRS Tax attorneys in Los Angeles California, and the founder of Tenina law. She has experience in bankruptcies, real estate planning, and complex tax matters. The information provided on this website does not, and is not intended to, constitute legal advice; instead, all information, content, and materials available on this site are for general informational purposes only. Information on this website may not constitute the most up-to-date legal or other information. This website contains links to other third-party websites. Such links are only for the convenience of the reader, user or browser; the ABA and its members do not recommend or endorse the contents of the third-party sites.
