How Do Tax Rates Work?

Tax brackets are separated into ranges of income and the more income you make the higher the tax rate. When you need to know what marginal tax rate or tax bracket you are in, it refers to the rate at which your next dollar of income will be taxed. See the chart below when referring to examples.

If you’re a single taxpayer and your income is $42,000, your next dollar of income is $42,001 and you are in the 22% marginal tax bracket. However, you don’t pay 22% taxes on all your income. You pay 10% on the first $10,275, then 12% on the next $31,500 ($41,775-$10,275), then 22% on the next $47,300 ($89,075-$41,775), and so on. See the example next to the income tax chart. Even though you are in the 22% marginal tax bracket, you don’t pay 22% taxes on that much of your income since you don’t go that far into the bracket. The average of all your tax brackets for your income is your effective tax rate, which is 11.56% in this example.

If you completely fill up a tax bracket and fall into the next one, the Base Taxes are already calculated for you. You can use the tax base, plus the additional income you earn in your marginal tax bracket to calculate your approximate taxes. Of course there is a lot more that goes into calculating your taxes, such as the standard deduction or itemized deductions, etc.

Knowing how your income is taxed can be confusing, which is why we suggest you work with a CPA and Financial Advisor if you have a substantial amount of income or wealth. Navigating taxes can be tricky and should be taken into consideration when making financial decisions. If you fall into this category, reach out to us for assistance, we’d be happy to help.

Please note, changes in tax law may occur at any time and could have a substantial impact upon each person’s situation. Raymond James and its advisors do not offer tax or legal advise. You should discuss any tax or legal matters with the appropriate professional.