Did you know that all your income is not taxed at "your marginal rate?"

You Pay Too Much Income Tax Not to Understand How it Works.

Most people do not understand how our progressive income system works.

It’s time for you to learn if you are one of the many.

What’s the difference between your marginal income tax rate and your effective income tax rate?

Knowing your marginal income tax rate is very important because it could influence tax planning strategies.

Whether you received a bonus from work or are retired and considering taking an IRA distribution or IRA Roth conversion, understanding how that extra income impacts your taxes is important. I just had a client review meeting and while explaining tax brackets realized it’s quite possible many people do not understand how their personal income taxes are calculated.

The confusing part for most people is understanding the difference between your marginal tax bracket and your effective tax rate.

Your marginal tax bracket is the rate that your next dollar of income would be taxed. For example:

Using the 2017 information below for a married couple filing jointly making a adjusted taxable income (gross income – deductions) of 50,000, their marginal tax rate is 15%. SEE TABLE BELOW

Their first $18,650 of income is taxed at 10% for a total tax of $1,865.
The income over $18,650 is taxed at 15% up to $74,900.
In this case one more dollar in income it would be taxed at the 15% rate, so 15% is the marginal tax bracket.

If your joint income was $200,000 you can see that your tax is tiered at several levels. Your first $18,650 is taxed at 10%, the next $57,250 is taxed at 15%, the next 75,200 t 25% and the money over $153,100 to the $200,000 adjusted gross income is taxed at 28%. IF THEY HAD ANOTHER TAXABLE DOLLAR IT WOULD BE TAXED AT 28%. THAT MEANS THAT 28% IS THEIR MARGINAL TAX BRACKET.

The table below makes it easy to calculate total tax owed at any taxable income, and in the $200,000 adjusted gross income example the tax would be:

$1,865 ($18,650 x 10%).
$8,587 ($75,900-$18,650) = ($57,250 x 15%).
$19,300 ($153,100-$75,900)= ($75,200 x 25%).
$13,132 + 28% times the amount over $153,100 ($200,000-$153,100) X 28%.
= $42,051 total tax owed.

Since the last dollar of income fell in the 28% tax bracket than 28% is their Marginal Income Tax Bracket.

The tiered tax brackets led to $42,051 in tax owed on the $200,000 adjusted taxable income.

To calculate the EFFECTIVE TAX RATE divide the gross income by the tax owed.

If the gross income was $250,000 (before deductions) and the tax was $42,051, the EFFECTIVE TAX RATE is 16.8% ($42,051/$250,000) for the same taxpayer that had a 28% marginal tax rate.

By using the tables below you can easily see what your marginal tax rate is and compute your effective rate by plugging your numbers into my examples above.

If you have any questions about this please feel free to call me to discuss. IRS Tax Table

TIME TO PLAN FOR 2018 TAXES – CLICK HERE FOR EVERYTHING YOU NEED TO KNOW

By seeing how this works it will become very apparent that higher income people pay most of the income tax in the U.S. In fact, most American workers do not pay any federal income tax at all due to the standard deduction and income tax credits. That’s is why it is nearly impossible to give the majority of Americans a tax cut. How can you give a cut if they’re not paying income tax in the first place.

Top 20% of Americans Pay 87% of all income tax.

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