Tax Brackets: Many people do not understand marginal income tax and how it affects them.
In turn, they can end up making financial decisions that are actually less beneficial in the long run. One of the most common misconceptions is that moving into a higher tax bracket (e.g., from a salary increase) has a negative impact for the taxpayer because more tax is due.
For example, if you move from the 25% tax bracket to the 28% tax bracket, you may think that all of your income is taxed at that higher rate. However, only the money that you earn within the 28% bracket is taxed at that rate.
The marginal income tax rate system is known as a “gradual tax schedule.” That basically means: as you make more money, you pay more tax.
Marginal Income Tax Brackets
There are currently 6 marginal income tax brackets for each filing status:
10 %, 15 %, 25 %, 28 %, 33 %, and 35 %
Your marginal tax bracket is the highest tax rate that you will pay on your income.
Minimize Your Tax Liability
If you are close to one of the marginal tax bracket limits, you can intentionally avoid moving into the next tier by controlling the amount of income that you earn. However, it’s recommended that you run the numbers and consider your particular situation before implementing a tax strategy, because owing less tax means earning less income.
For example, let’s consider a married couple filing a joint income tax return. If that couple earns between $16,751 and $68,000 during the tax year, they fall into the 15% tax bracket (i.e. their income is taxed at 15%). But, if the couple earns more than $68,000 that year, the amount of income that exceeds $68,000 is taxed at 25%, which is the next tax bracket. This means that if the couple earns $70,000 during the year, only $2,000 (i.e. the amount over $68,000) is taxed at 25%.
While it is the goal of many taxpayers to keep their income in the lower tax bracket, the gradual tax schedule ensures that not all of your income is taxed at a higher rate.
The current marginal tax brackets are set to change after 2010 unless Congress extends them or passes a new law. Otherwise, the income tax brackets will reset to their pre-2001 values which included 5 brackets (15%, 28%, 31%, 36%, and 39.6%).
If you understand marginal tax brackets and how they work, you can use this knowledge to help save money on your income taxes.