What Are Tax Brackets?

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In the U.S., we have decided, through the laws created by our elected officials, that individual taxable income should be taxed at progressive rates. In other words, the more taxable income you have, the bigger percentage of that income you have to pay in taxes.

To attempt to simplify the application of this approach, the lawmakers created income ranges that are taxed at different rates, creating tax brackets. Based on current laws, taxable income (i.e. amount reported on line 43 of Form 1040) ranging from $0 to $8,375 by a single tax filer is taxed at a rate of 10%. The income reported from $8,375 to $34,000 by this same single filer is taxed at a higer rate of 15%. Here are the 2010 tax brackets for single filers:

2010 Federal Income Tax Brackets for Single Filers

Tax Brackets

Brief History of U.S. Tax Brackets

Since 1913, when the federal income tax was made permanent, we have had tax brackets. Our first set of brackets was fairly simple, with rates ranging from 1% to 7%. This initial set of brackets applied to all tax filers. In the 40s and 50s, different tax brackets were created for Single, Married Filing Jointly, Married Filing Separately, and Head of Household.

The highest federal tax rate ever levied in the U.S. was a whopping 94% for income over $200,000 back in 1944 and 1945. Tax rates and income brackets can change each year, based on new law and inflation adjustments.

“What Tax Bracket Am I In?”

One of the most common questions tax filers have is, “what tax bracket am I in?” We already know, based on the brackets above, that every filer is effectively in every tax bracket, up to their highest. So we can assume that the question really is, “what is my highest tax bracket?” The rate associated with your highest bracket is actually called your marginal tax rate. For instance, if you make $90,000 in 2010, you will have a 28% marginal tax rate.

Does this mean that you will pay 28% of $90,000 in taxes for the year? No. It just means that the highest margin of income you report will be taxed at 28%. This is useful because generally every dollar you add to your current income will be taxed at that highest rate. Likewise, every reduction you make (i.e. tax deductible expense) will generally save you that percentage in tax dollars.

What you might be more interested in knowing though is your effective tax rate. This is the percentage of your taxable income that was actually paid in taxes. To determine your effective tax rate from last year, find your tax return and divide your total tax by your taxable income. Think of this as your average rate across all brackets.

5 responses to “What Are Tax Brackets?”

  1. I’ve paid $16,000 in taxes and my tax return shows I still owe $2,000 on a 60K salary? According to the tax bracket I fall in, I should only be owing $11,000 and not $7,000 more than that!


    This is a bit confusing for my situation.

    Im on a $60,000 salary, so based on the bracket I fall in, this is my calculation:

    $4,681 plus 25% of the amount over $34,000

    $4,681 + $6,500 = $11,181

    * I have earned $60,000 (before tax) in 2010.

    * 26% of that was withheld in total (which is about $16K), as shown on my W-2

    * Now TurboTax shows that I owe NY State $1886 more

    * This brings me to paying up to $18K in taxes — around 30% of my income.

    Is this normal or am I being overtaxed? Please help!

  2. Great points, Joe. For planning purposes, the marginal is the way to go. But for fun, I like the effective. It’s cool to know what % you actually paid. But I agree that it’s not an actionable number. I do see a bit of value in comparing effective rates from year to year though.

  3. PT – excellent overview on a sometimes complex topic. I tend to focus strongly on that marginal rate, as it drives many investing decisions. Roth vs Traditional (for either 401(k) or IRA.) What does my mortgage really cost me? Donate in December or January?

    That effective (average) rate holds no interest for me as it’s really a distraction. Just like my 6 hour car ride from Boston to NYC tells you nothing. 6 hrs of slow traffic vs a 4 hr ride and long stop on the way for lunch.

    The single making $90K will have taxable income in the 25% bracket after exemption/deductions, but in a good year or after a raise is back up into that next bracket.

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