Read this article to have an understanding of the difference between your effective tax rate and your marginal tax bracket.
Understanding Tax Brackets
I was thinking about income taxes and am a bit confused. The accountant said that my husband and I paid about 17% in tax but said that we were in the 25% marginal tax bracket. What does that mean?
Income taxes are not simple. Discussions about income taxes normally include not only terms like tax rate and tax bracket, but also terms such as adjusted gross income and taxable income.
Let's start with some basics on how our tax system works.
First, you add up all your income. For most people, this includes wages, interest, investment income and a few other things. That total is called adjusted gross income.
You then subtract your itemized deductions (mostly mortgage interest, state and local taxes and charitable contributions). If you do not have a lot of those items, you use what is called the standard deduction. You also subtract an amount for personal exemptions. What you are left with is your taxable income.
Your taxable income is then taxed at different rates. Think of our tax system like stair steps. Each step represents a tax bracket of income that is taxed at a certain rate. The higher you go, the higher the tax rate on the income in that bracket. "Segments" of income at lower levels are taxed at lower rates and "segments" of income at higher levels are taxed at higher rates.
Income Tax Rate Schedules for 2018
Another way to think of the term tax bracket is to consider it to be the rate of tax you pay on your last dollar of taxable income. If you are in the 25% tax bracket, you last dollar of taxable income was taxed at 25%.
Let's assume you are married, filing a joint return and had taxable income of $110,000 for 2018. The first $19,050 of income is taxed at 10%. The next $58,350 ($77,400 minus $19,050) was taxed at 15%. The last $32,600 ($110,000 minus $74,900) was taxed at 25%.
Your total tax was $18,807, or about 17% of your taxable income. However, you are in the 25% marginal tax bracket because that is the highest tax rate applied to any of your income.
As mentioned earlier, income taxes are not simple and everyone's tax situation is different. These was simplified and if you want to learn more, talk further with your accountant to get a better understanding of the tax rules apply to you.
Read other situation analysis articles