Some people dread tax because they worry about paying too much or not paying enough. Learning more about tax basics can help you make informed decision and minimize your tax burdens. A topic many people have questions about is tax brackets and how they work.
What Are Tax Brackets
Here in the United states, we have a progressive tax system. As you earn more money, you have a higher tax rate. The amounts within the tax brackets are adjusted for inflation every year. Congress establishes the tax rates and right now the tax brackets are from 10%-35%.
Some people believe that tax brackets only apply to your income from an employer. That’s not true, it includes income from different sources. Tax brackets are based on your taxable income, which can be very different from your gross income, depending on your deductions and personal exemptions.
When you fill out your W-4, try to make it as accurate as possible so your withdrawals can cover your tax obligations.
How Tax Brackets Work
Some people think if they get a raise at a job or earn enough money that puts them in the next tax bracket, they’ll see a huge increase on their taxes. That’s not the case. Your income is not completely taxed at the new tax bracket you fall in. The additional income from a raise will be taxed at the new rate.
We’ll us an example to explain how the tax brackets work. Suppose you’re filing single and have a total of $39,000 in taxable income for 2009. Here’s how your taxes are calculated with the brackets:
- Your first $8350 will be taxed at 10%.
- From there, from $8351 to $33,950 of your taxable income will be taxed at 15%.
- The rest of your income ($5,050) will be taxed at 25%.
So even though you fall into the 25% tax bracket, you’re not paying 25% on all of your taxable income. You will be effectively taxed at a lower rate.