Taxpayers that don’t understand the federal tax table often erroneously think that the slightest increase in income will be offset with a higher tax bracket rate. Even though a jump in income could result in a higher bracket, the U.S. income tax rate is a progressive tax. This basically means that a jump in the tax rate only applies to the amount of income over the rate amount.
How the Federal Tax Rate Works
A progressive tax rate can be a bit confusing. To illustrate how the income tax rate works, we’ll use the 2010 federal tax table:
- If taxable income is between $0 and $8,375 the tax bracket = 10%
- If taxable income is between $8,375 and $34,000 the tax bracket = 15%
- If taxable income is between $34,00 and $82,400 the tax bracket = 25%
- If taxable income is between $82,400 and $171,850 the tax bracket = 28%
- If taxable income is between $171,850 and $373,650 the tax bracket = 33%
- If taxable income is above $373,650 the tax bracket = 35%
As an example we’ll assume a taxpayer’s taxable income is $75,000. The amount of income taxes paid and the rate on $50,000 would be:
- $8,375 @ 10% = $838
- $34,000 - $8,375 = $25,625 @ 15% = $3,844
- $50,000 - $34,000 = $16,000 @ 25% = $4,000
Total tax = $8,682
In this example of $50,000, the effective tax rate on taxable income is actually 17.4% ($8,682/$50,000), not the 25% tax bracket that the taxpayer is in.
Taxable Income and the Federal Tax Bracket
In the examples given above, the key is “taxable income”. The effective rate of 17.4% is based on taxable income, not total or gross income. The IRS allows for certain deductions from gross income to calculate actual taxable income. Again we’ll use the above example of taxable income of $50,000.
If the person(s) in the above example were to take the standard deductions from IRS Form 1040, assuming they were married filing jointly with no other dependents, the deductions would equal $18,700. The standard deduction for 2010 is $11,400 and the exemptions per person are $3,650 ($11,400 + $3,650 + $3,650 = $18,700).
Taking the taxable income of $50,000, plus the standard deductions and exemptions of $18,700, the total household gross income is $68,700. The actual effective tax rate would equal 12.6% ($8,682/$68,700).
If the household can itemize their deductions for more than the standard deduction of $11,400, they can use IRS Schedule A of Form 1040. If the household has more itemized deductions than the standard deduction it would decrease the effective tax rate even more.
Source:
irs.gov
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James Clausen - Clausen received a Bachelors Degree in Business Administration in Automotive Management and Marketing at Northwood University, graduating ...
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