Tax brackets play a crucial role in determining how much income tax you owe. The United States uses a progressive tax system, which means that different portions of your income are taxed at different rates. The more taxable income you have, the higher the tax rate you’ll pay .
How do federal tax brackets work?
Federal tax brackets are not as straightforward as they may seem. Instead of looking at what tax bracket you fall into based on your income, you need to determine how many individual tax brackets you overlap based on your gross income . Let’s look at an example to understand this better:
Example: Suppose you are a single individual who earned $40,000 of taxable income in the 2023 tax year. Technically, you would be aligned in the 12 percent tax bracket, but your income wouldn’t be levied a 12 percent rate across the board. Instead, you would follow the tax bracket up on the scale, paying 10 percent on the first $11,000 of your income and then 12 percent on the next chunk of your income between $11,001 and $44,725. Since you don’t make above $44,725, none of your income would be taxed at the 22 percent rate .
In summary, tax brackets determine the range of incomes subject to a certain income tax rate. As your income increases, different portions of it are taxed at increasing rates . It’s important to note that tax deductions and credits can also affect your tax bracket and the amount of tax you owe .
How many tax brackets are there?
For the tax years 2023 and 2024, there are seven different federal income tax brackets in the United States. The tax rates for these brackets are set based on your income and tax filing status, such as whether you file as Single or Married Filing Jointly .
Marginal Tax Rate vs. Effective Tax Rate
When discussing tax brackets, it’s important to understand the difference between the marginal tax rate and the effective tax rate. The marginal tax rate refers to the tax rate applied to the last dollar of your taxable income. It determines the tax paid on an additional dollar of income that takes you into a higher tax bracket .
On the other hand, the effective tax rate is the average rate at which your total income is taxed. It takes into account the different tax brackets you fall into and the corresponding tax rates for each bracket. Your effective tax rate is typically lower than your marginal tax rate because not all of your income is taxed at the highest rate .