In a perfect world, you could look at tax bracket (10%, 25%, etc), multiply it by your income, and voilà! You know how much to pay this year in taxes.
Unfortunately, it’s not that simple. Tax brackets give you only a very general idea of how much you’ll pay in taxes. For that reason, you won’t find your tax bracket very useful if you’re doing your taxes on your own.
But there’s good news: if you’re in the 25% tax bracket, you won’t actually pay 25% of your income in taxes. You’ll pay less. Much less.
If you want to understand why, read on.
Your marginal tax rate vs. your effective tax rate
The first thing to know is the difference between your marginal tax rate and your effective tax rate.
Your marginal tax rate is the percentage of your income that you would theoretically pay in taxes, based on your current income. However, this figure excludes other tax-influencing factors like marital status, tax write-offs, etc, and it also doesn’t account for progressive taxation. Your marginal tax rate is just the first part of the equation.
Your effective tax rate as how much of your taxable income you will actually pay, after accounting for all factors. For example, even if your marginal tax bracket is 15%, you could pay an effective tax rate as low as 5%.
How it works
Why is your effective tax rate lower? For several reasons.
First, you aren’t taxed on your entire income — you’re taxed on your taxable income. You can look at your tax return from last year and find the item that says “Taxable Income.” You can find it at line 6 on the 1040-EZ form, line 27 on 1040A form, or line 43 on the 1040 from.
Once you know your taxable income and your filing status, you can figure out what tax bracket you fall into.
Thanks to the government’s recent tax cuts, your tax bracket will look different this year than it did the year before. Use this chart to find out where you stand:
|2017 tax rate||2018 – 2025 tax rate||Income for single taxpayers||Income for married/joint taxpayers|
|10%||10%||Up to $9,525||Up to $19,050|
|15%||12%||$9,525 – $38,700||$19,050- $77,400|
|25%||22%||$38,700 – $82,500||$77,400 – $165,000|
|28%||24%||$82,500 – $157,500||$165,000 – $315,000|
|33%||32%||$157,500 – $200,000||$315,000 – $400,00|
|33-35%||35%||$200,000-$500,000||$400,000 – $600,000|
|39.6%||37%||$500,000 or more||$600,000 or more|
The second reason why you pay less than your tax bracket dictates is because your income isn’t all taxed at the same rate. It’s taxed incrementally, based on whether it’s above or below a given bracket. The more money you make, the more you are taxed on it.
Let’s illustrate with a simplified example.
Let’s say you are a single taxpayer with a taxable income of $80,000. As you can see from the chart, you are in the 25% tax bracket. Does that mean you’re paying a quarter of your taxable income, or $20,000, to the government? No, it does not.
Instead, the government will tax each chunk of your income that falls into a bracket at its corresponding rate. You’ll pay 10% in taxes on the first $9,525 of your income. Then, you’ll pay 15% in taxes on the income you made between $9,525 and $38,700: $29,175 in total. And you’ll pay 25% in taxes on the remaining $41,300 of your income ($80,000 – $38,700).
That means that after deductions and exemptions, you’ll pay much less than 25% of your income in taxes.
Should you worry about changing tax brackets?
Not really! If you get a raise which bumps your taxable income up to $84,000, your taxes won’t suddenly skyrocket. Only the income you made above $82,500 will be taxed at 28%. That’s only a difference of only $420 in taxable income. As such, you should never turn down a raise out of fear of entering a new tax bracket. You will have to pay more in taxes, but not by as much as you think!
And raises aren’t the only thing that can affect your tax bracket. Losing a deduction increases your taxable income, and as such, can also bump you into a higher tax bracket.
The percentage on your tax bracket looks scary, but fortunately, you’ll never actually have to pay that much. When you account for progressive taxation, taxable vs. untaxable income, deductions, and other factors, your effective tax rate looks a lot more reasonable.
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