Jul 16, 2021 What is my Tax Bracket?
We often hear the question, “what is my tax bracket?” Generally, a tax bracket is the income tax rate at which a taxpayer is taxed for a certain range of income. The income ranges vary, depending on filing status. We will look at the difference between marginal tax rate and effective tax rate.
Marginal Tax Rate
Tax brackets are named for their marginal tax rates, which refers to the rate at which a range of income will be taxed. There are seven marginal tax rates in 2021: 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
The marginal tax rate is the rate at which the last dollar earned is taxed, not the amount that all dollars earned are taxed. Let’s calculate the marginal tax rate for a single individual earning $80,000 of W-2 income and taxable income of $67,450 after the standard deduction of $12,550. Taxes are calculated on the taxable income number of $67,450 which falls within the $40,526 to $86,375 Single tax bracket range as shown below. The last dollar earned was taxed at a 22% marginal tax rate so they are within the 22% marginal tax bracket. They would stay within this bracket until the individual’s taxable income increased to $86,376, at which they would move into the 24% marginal tax bracket. This is not the effective, or average, tax rate though. We will look at that next.
Year 2021 federal income tax rates for single and married taxpayers are as follows:
Click here to see the full tax rate schedule.
Effective Tax Rate
The effective tax rate is the average rate of tax paid on taxable income and not just the rate paid on the last dollar earned. We can look at the same example above to calculate the effective tax rate. By looking at the single tax schedule above and having an $80,000 W2, it may look like the income would be taxed at 22%, however, it is not quite that simple. First, deductions from income need to be subtracted from the income. For 2021, a single person under age 65 has a standard deduction against income of $12,550. Assuming no other deductions, the taxable income would be $67,450. To calculate total taxes owed to a Single taxpayer with taxable income of $67,450, tax needs to be calculated in each bracket.
The taxable income up to $9,950 will be taxed at 10% ($9,950 x 10%) which equals $995 of tax.
The taxable income over $9,950 and up to $40,525 ($40,525-$9,950=$30,575) will be taxed at 12% ($30,575 x 5%) which equals an additional $3,300 of tax.
The taxable income over $40,525 up to $67,450 ($67,450-$40,525=$26,925) will be taxes at 22% ($26,925 x 22%) with equals $5,923 additional tax.
All tax owed in each bracket is then added together; the $995 in the 10% bracket plus the $3,300 in the 12% bracket plus the $5,923 in the 22% bracket. This adds up to a total tax bill of $10,218.
The effective rate is the total tax of $10,218 divided by the taxable income of $67,450 to get a 15% effective tax rate. Much lower than the 22% marginal tax rate.
Something to consider is that not all income is taxed at the above tax brackets. The most common difference can be found with long term capital gains and qualified dividends that are generally taxed at preferential tax rates. If you would like to better understand your marginal tax rate and your effective tax rate, you can talk with your CPA or ask your advisor.
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