Solutions to Make Better Decisions with Your Money

How Tax Brackets Work: Examples and Myth Busting

How Tax Brackets Work - TaxACT

What tax bracket are you in, and what does that really mean?

Your tax bracket, roughly speaking, is the tax rate you pay on your highest dollar of taxable income.

Your tax bracket is not the tax rate you pay on all of your income after adjustments, deductions and exemptions.

Your tax bracket only determines the amount your income tax increases if you earn one additional dollar of income (ignoring the effects of rounding.)

We have tax brackets in the U.S. because we have a progressive income tax system. That means the more money you make, the higher a tax rate you pay. Your tax bracket becomes progressively higher.

Progressive rates are based on the concept that high-income taxpayers can afford to pay a high tax rate.

Low-income taxpayers pay not just lower taxes overall, but a lower percentage of the income they do have.

Here’s how tax brackets work, an example

Say you’re single with no dependents, and your taxable income is $9,000.

Your marginal tax rate, according to the Federal Income Tax Brackets chart below, is 10%. You pay $900 in income tax. That’s simple.

What if your taxable income is $19,000?

As a Single filer, you’re now in the 15% tax bracket. That doesn’t mean you pay 15% on all your income, however.

You pay 10% on the first $9,075, plus 15% of the amount over $9,075.

Here’s the math:

First tax bracket: $9,075 X 10% = $907.50
Second tax bracket: ($19,000 – $9,075) X 15%  = $1,488.75
Total income tax: $2,396.25

Find your tax bracket in the following chart based on your filing status and 2014 income:

Federal Income Tax Brackets, 2014 Tax Year (Source: IRS Publication 505)

Tax rate Single filers Married filing jointly or qualifying widow(er) Married filing separately Head of household
10% Up to $9,075 Up to $18,150 Up to $9,075 Up to $12,950
15% $9,076 – $36,900 $18,151 – $73,800 $9,076 – $36,900 $12,951 – $49,400
25% $36,901 – $89,350 $73,801 – $148,850 $36,901 – $74,425 $49,401 – $127,550
28% $89,351 – $186,350 $148,851 – $226,850 $74,426 – $113,425 $127,551 – $206,600
33% $186,351 – $405,100 $226,851 – $405,100 $113,426 – $202,550 $206,601 – $405,100
35% $405,101 – $406,750 $405,101 – $457,600 $202,551 – $228,800 $405,101 – $432,200
39.6% $406,751 or more $457,601 or more $228,801 or more $432,201 or more
Find out which IRS tax bracket you are in. Estimate your tax year 2014 tax rate here.

Busting a tax bracket myth

Some people think if they earn more money, they are in a higher tax bracket.

They think they pay more taxes and may actually have less money left over than they would if they had earned less.

Using the prior example, you can see that’s not true.

Each dollar you earn only affects the tax rate on additional income. It does not change the tax rate you pay on dollars in lower tax brackets.

Unless you are in the lowest tax bracket, you actually have two or more tax brackets.

If you are in the 25% tax bracket, for example, you pay tax at three different rates – 10%, 15%, and 25% – on different levels of your income.

Based on the tax brackets, you always have more money after taxes when you earn more.

Of course, tax rates are not the only factor in your final tax bill.

When you have higher income, you can lose tax benefits, such as education credits, that phase out at higher income levels.

It pays to use TaxACT as a planning tool to see how different levels of income affect your tax benefits and final tax bill.

Use your tax rate to make better decisions

For example, say you are considering working overtime and making an additional $1,000.

If you know you’re in the 25% tax bracket, you’ll pay $250 in income tax on that money.

You’ll also pay 7.65% in Social Security and Medicare employee withholding, plus any state tax and other mandatory withholding.

Earning an additional $1,000 is a great idea, but you don’t want to be surprised when you discover that one-third or more of your pay goes to taxes.

If you’re thinking about making cash or noncash contributions before the end of the year, knowing your tax bracket helps you determine how much your contribution will save you in taxes, assuming you are already itemizing your deductions.

For example, if you’re in the 25% tax bracket, every $100 you contribute to charity saves you $25 in federal income taxes.

Knowing your tax rate also helps when you’re thinking about making a retirement plan contribution.

If you contribute to a traditional 401(k) plan or traditional IRA, you’ll reduce your state and federal income tax for this year. That makes your contribution more affordable now.

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About Sally Herigstad

Sally Herigstad is a certified public accountant and personal finance columnist and author of Help! I Can't Pay My Bills, Surviving a Financial Crisis (St. Martin's Griffin). She writes regularly at CreditCards.com, Bankrate.com, Interest.com, RedPlum, and MSN Money. She is an experienced speaker and a member of Toastmasters International. Follow Sally on Twitter.