Don't Fear the Tax Bracket
March 09, 2016
Do you REALLY understand how tax brackets work?
Let’s talk about taxes. Taxes are something everyone has to pay, yet so few understand. One key aspect on how much you will have to pay in income tax is the tax bracket you are in. There is a widespread misconception on how the tax brackets work. The United States, as of 2016, has a marginal tax rate system. What tax bracket are you in, and what does that really mean? To understand this, we need to look at the current tax bracket ranges. Also to keep things simple, we are just looking at a single individual’s taxable income, without any deductions, exemptions, and all the other factors.
2016 Federal Income Tax Rates (Single):
Income Tax Rate
$0 - $9275 10%
$9275 - $37,650 15%
$37,650 - $91,150 25%
$91,150 - $190,150 28%
$190,150 - $413,350 33%
$413,350 - $415,050 35%
Over $415,050 39%
The easiest way to understand how these tax brackets work is through examples:
1.) Let’s say your taxable income is $5000 for 2016. That would put you in the 10% tax bracket. 10% of $5000 is $500 in income tax. Simple as that.
2.) Now, let’s say you made $20,000. That would put you in the 15% tax bracket. Here is where the common misconception lies. Your tax bracket is not the tax rate you pay on all of your income. In this example, you are not paying 15% on your entire $20,000. Since we are on a marginal income tax system, the 15% is the tax rate that you pay on your income above the 10% tax rate, or above $9275. For that reason, if you were making $20,000, your income tax is 10% of your first $9275 of income, or $927.50 plus 15% of $10,725 (the amount of your $20,000 income over $9275).
3.) If someone was to say they are in the 28% tax bracket, what that actually means is that they are in the 10%, 15%, 25%, and 28% tax brackets. The 28% is just the amount that they will be paying on their highest dollars of taxable income.
There are people out there who think you could possibly be taking home less money by barely crossing the threshold into the next bracket. Based on your understanding of how tax brackets work, you can explain to them that you will always have more money after taxes when you earn more.
**NPC does not provide tax nor legal advice.