Understanding Tax Brackets
If there’s one thing everyone can agree on, it’s that taxes in the United States are confusing.
There are last-minute changes to laws, forms for everything under the sun, and (at least if you have any non-wage income) always an element of uncertainty about exactly how much you will owe come tax day.
It’s complicated stuff.
One of the most commonly misunderstood parts of the system is how the tax brackets work.
You’ll hear folks talking about things like “being in the 28% bracket” and complaining that they pay 28% of their income in federal taxes. But that is NOT how being in the 28% tax bracket works.
You don’t pay 28% of your taxable income to the federal government in taxes if you’re in the 28% bracket. Instead, you pay LESS than 28%. The same thing is true for almost all of the other tax brackets.
For tax year 2010, there are six tax brackets (10%, 15%, 25%, 28%, 33%, and 35%), and the taxable income thresholds (the dollar amounts that determine which tax bracket you are in) for the brackets vary depending on filing status.
To simplify things (a little!), let’s take a look at the 2010 tax rate schedule for filing as single:
(You can view the complete 2010 tax rate schedules for other filing statuses on the IRS web site. Note that these will change a bit for tax year 2011 after the 2011 tax brackets come out, and that the tax rate schedules themselves aren’t by any means all that’s needed to figure your taxes. Also, I am not a tax professional.)
Basically, what the chart above shows is that a person with a filing status of single will pay 10% of up to $8375 of their taxable income to federal taxes.
So, if their taxable income happened to be $8375, they would pay $837.50 in taxes. This lowest bracket is the only tax bracket where the amount a person pays in federal taxes on their taxable income does equal the percentage indicated by the bracket.
But what if a person had more than $8375 in taxable income?
Well they would first pay 10% of their taxable income up to the $8375, and then pay 15% on the amount of their taxable income that is between $8375 and up to $34,000 to federal taxes.
For example, if their taxable income was $27,000, they would pay 10% ($837.50) of the first $8375 plus 15% ($2793.75) of $18,625 ($27,000 minus $8375), for a total of $3631.25 in federal taxes (or approximately 13.4% of their taxable income).
The same concept applies to the remaining brackets.
In other words, the taxes get progressively higher on the portion of the taxable income that is above the threshold for each tax bracket. They don’t get progressively higher on all of the taxable income once someone starts making a certain amount of money, which is the common misunderstanding.
Please consult your tax professional to understand how the tax brackets impact your individual situation.