Even though most everyone with an income pays taxes, not everyone has heard of tax brackets. And just because someone has heard of them, doesn’t mean that they understand them. Hopefully I’ll be able to clear up some of the confusion on the subject.
As explained by Wikipedia, Tax brackets are the divisions at which tax rates change in a progressive tax system. Different levels of income are taxed at different rates. This is why you may have heard people say that getting a raise has bumped them into a higher tax bracket. This, however, is the source of most confusion since people think they will be getting taxed more on their income, and this is only partially true.
The tax bracket you are in is the rate that you pay on the last dollar that you earn. It is not the rate at which all of your income is taxed. Therefore, you really shouldn’t ever be worried about moving into a higher tax bracket. In order to fully understand how it works though, it’s best to see an example. We’ll use the tax rates for the case of married filing jointly.
The first $15,650 is taxed at 10%. Any income over this amount up to $63,700 is taxed at 15%. Any income over this and up to $128,500 is taxed at 25%. It works the same as you move up through the tax brackets.
So, let’s say that you and your wife earn a combined income of $150,000. The tax that you are responsible for is $24,972.50 plus 28% of the amount over $128,500 which is $6,020 for a grand total of $30,992.50. This works out to a tax rate of approximately 20.7% which is significantly lower than the 28% tax bracket that you would be in.
As you can see, the actual tax rate that someone pays will be different than the tax bracket that they are in. Essentially everyone will pay their own effective tax rate based on their level of income. Just remember that this only applies to the Federal Income Tax rates. Their is also Social Security payments and state and local taxes which must also be factored in to determine your total tax bill.
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