Tax Brackets and Marginal Tax Rates: Understanding How They Actually Work

Do you know what the federal ordinary income tax brackets are and the tax rates that apply to you? If you’re unsure, you’re not alone. Many people are under the impression that the more they earn, the higher their tax rate will be on all their income. While it may be true that your tax rate increases with higher income, it does not mean all your income will be taxed at the higher rate.

Sound complicated? Fortunately, it’s not as bad as it may seem at first glance. Let’s answer a few of the most common questions regarding tax rates and tax brackets.

What is a tax rate

A tax rate is simply the percentage at which your income is taxed. For example, if you were single and had only $9,000 of taxable income, you’d fall into the 10% federal tax bracket. To determine your tax, simply multiply the $9,000 by 10% to get your tax due of $900.

So far, so good. However, there’s another important thing you need to know—the United States has a progressive tax system. In a progressive tax system, the tax rate increases as your taxable income increases; however, only the income that passes into the next higher tax bracket is taxed at a higher tax rate. 

What is a tax bracket?

Currently, there are seven federal tax rates that range from 10% to 37%. Each of those tax rates only apply to certain levels of taxable income, known as a tax bracket. As your taxable income increases, it crosses from one tax bracket to the next higher tax bracket, where a new tax rate applies. Even as your income moves into a higher tax bracket, the income that fell into a lower tax bracket will still be taxed at those lower tax rates.  

The tax brackets that apply to you will depend not only on how much taxable income you have but also on your filing status (which includes single filer, married filing jointly, married filing separately, or head of household). The table below shows the tax brackets and corresponding tax rates for each filing status.

2024 federal ordinary income tax rates and brackets

Let’s look at an example of how tax rates and brackets work. We have Sara and Tom who are married and file a joint tax return. After taking the standard deductions, they have taxable income of $125,300. Here’s how their federal taxes will be calculated:

• The first $23,200 of their taxable income falls into the 10% tax rate/bracket. That means the tax on this income is $2,320 ($23,200 x 10%).
• Next, $71,100 ($94,300 – $23,200) of taxable income falls into the 12% tax rate/bracket. The tax on this is $8,532 ($71,100 x 12%).
• Finally, the remaining $31,000 ($125,300 – $94,300) of taxable income falls into the 22% tax rate/bracket, resulting in $6,820 of taxes.

Sara and Tom’s total federal tax will be about $17,672 ($2,320 + $8,532 + $6,820). As you can see, Sara and Tom made their way through three tax rates/brackets, with a portion of their income being taxed at 10%, then at 12%, and the final bit of income being taxed at 22%. This same process works no matter how much income you have. The highest income taxpayers will progress through all seven federal tax brackets until they top out at the 37% tax rate, at which point all other income is taxed at the higher tax rate.

What is a marginal tax rate and why does it matter?

The highest tax rate that applies to you is called your marginal tax rate. When it comes to realizing additional income, the taxes you’ll pay on each additional dollar will be at your marginal tax rate. Knowing this tax rate comes in handy when it’s time to do some tax planning because it helps determine which tax strategies could work best for your situation.

Here’s an example of how knowing your marginal tax rate can be very useful. Let’s say your normal marginal tax rate is 24%, but this year, you’re going to end up with an unexpectedly large bonus. However, that bonus pushes you in the 32% tax bracket, but you really don’t want to be taxed at that higher rate. What can you do?

One option could be to contribute some of that bonus to a tax-deferred retirement account. Assuming you have access to a 401(k) plan, and you have not maxed out your contributions, making additional tax-deferred contributions could reduce your taxable income and drop your marginal tax rate back down to 24%, saving you 8% on taxes on the income that would’ve fallen into the 32% tax rate/bracket.

One thing to keep in mind is that you could have multiple marginal taxes rates. You’ll potentially have a marginal tax rate for federal ordinary income, federal long-term capital gain income, and state taxes as well.

Bottom line

Remember, these are all just simple examples of how taxes are calculated. There are many other considerations when it comes to determining your total tax bill, such as what other deductions and credits you’re allowed. Also, these examples only look at federal taxes, and depending on where you live, state taxes could also be due. We believe tax planning is an important part of your overall wealth management. That’s why we recommend meeting with a tax and/or financial planning professional to get guidance specific to your situation.

TD Ameritrade does not provide tax advice. Clients should consult with a tax advisor with regard to their specific tax circumstances.