How Do Tax Brackets Actually Work?

How Do Tax Brackets Actually Work?

March 26, 2020 | Articles, Blog | 3 Comments

How Do Tax Brackets Actually Work?


Have you ever heard somebody worry that getting
a raise would bump them into a higher tax bracket? The idea that having a higher salary could
somehow mean making less money sounds wrong and it is. This fear is based on a common misconception
about federal income taxes. So let’s look at how tax brackets actually
work. The main misconception is that being in a
certain tax bracketť means that all your income gets taxed at that rate. That’s not how it works. U.S. federal income taxes are progressive,
which means additional income is taxed at a higher rate. But and here’s the key tax rates are
marginal, which means not all your income is taxed at the same rate. Income is actually divided into different
levels, or brackets, that have different tax rates. Each dollar of income is only taxed at the
rate of the bracket it falls into. Think of these brackets like a series of buckets. Each bucket holds a certain amount of money
and is taxed at a certain rate. The government determines the size and rates
for each bucket and usually adjusts them each year; the ones we’re showing here are for
2020. So, suppose your taxable income was $55,000. As of 2020, the first bucket holds $9,875
and is taxed at 10%. Then, in the next bucket, you pay 12% on $30,250,
and so on. The rate of the highest bucket your money
starts filling is your marginal tax rate what people often call their tax bracket. So, in this example, only $14,875 of taxable
income is taxed at 22%. But because your income falls into multiple
tax brackets, the overall rate you actually pay is typically much less than the marginal
rate. The percentage you actually pay in taxes is
called your effective tax rate.ť However, determining your effective tax rate
is more complicated than just taking your salary and averaging all the brackets it would
fit into. That’s because not all your income actually
gets taxed. There are exemptions and deductions that could
reduce the amount of income that’s taxable. You could also get credits that reduce how
much you owe. We won’t get into the details in this video,
but the IRS provides calculators that can help you determine your taxable income. The important thing to understand is that
your effective tax rate is the total amount you paid in taxes divided by your taxable
income, which accounts for things like deductions. So, next time you worry about which tax bracket
you fall into and how big that new percentage is, remember that it’s just your marginal
tax rate. Your effective tax rate, the amount you’re
actually paying, is likely much lower. Thanks for watching. If you’re a smart investor looking to get
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3 Comments
  1. Lakshmi Prabhakar Koppolu

    Nice one ☝️

  2. Tem

    nice video you deserve more views

  3. Wayne Dejnak

    If I may, one needs to consider their standard deduction ($24,499 Married filing jointly or $12,200 Single) which subtracts the total amount of taxable income. It is quite possible that many "taxpayers" end up pay no federal tax and may actually receive earned income credit.
    However, those checks coming in the mail are all going to be potential tax consequence. My personal thoughts are we are all going to "pay" for these checks with the hidden tax of inflation. Let us see where CPI goes from here. We are currently around 258.

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