What are the tax brackets and how do marginal tax brackets work? Find out as we head into income tax season.
Do you know what tax brackets are, and what tax rates make up the federal tax brackets? If you're unsure, you’re not alone. After all, tax accounting is one of those rare topics that, at least for most non-accountant types, can be highly stressful and exceptionally boring at the same time.
And because tax time comes only once a year, we don’t really get to spend much time on a topic that, ultimately, many of us would rather avoid despite its importance to everyone’s bottom line.
Tax time this year, however, will be a bit different. Remember all that contentious talk about the tax reform bill that more or less dominated political media toward the end of 2017? Well, the bill passed, meaning that there are a number of significant changes that will likely affect how much you owe Uncle Sam (or how much Uncle Sam owes you) come April 2018.
But to fully understand the new legislation, at least the part concerning your tax payment or return, you will need a solid grasp of these two terms: tax brackets and marginal tax rates.
A tax rate is simply the percentage at which you are taxed. Here’s an example:
So far so good. However, there’s another important thing you need to know: the U.S. uses a progressive tax system, meaning that the more income you earn, the higher your tax rate. Consequently, people earning lower incomes will be taxed less than those earning higher incomes.
Currently, there are seven tax rates that generally divide taxpayers into seven different tax brackets, ranging from the lowest to highest income levels. And these rates are marginal rates, meaning, as you move from one bracket to the next, you’re taxed at a higher rate only on the income earned above the previous threshold. See the chart below.
For example, suppose you're a single filer and you earned $80,000 in 2017. You would pay 10% of the first $9525 in earnings, 15% of the money you earned between $9526 and $38,700, then 25% between $38,701 and your earnings of $80,000. That's what is meant by marginal rates.
Notice the differences between 2017 and 2018? With the exception of the 10% and 35% brackets, the tax rates are lower across the board. To get a better sense of how the new tax brackets will affect your income, a reliable tax calculator may help, or you can view the tax tables on the IRS web site. You may also wish to consult a tax professional for a more comprehensive view.
TD Ameritrade does not provide tax advice. Clients should consult with a tax advisor with regard to their specific tax circumstances.
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