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How do Federal Income Tax Brackets Work?

Written by Nickel - 29 Comments

On more than one occasion, I’ve received an e-mail asking for advice on how to keep from slipping up into the next tax bracket. The motivation behind such e-mails is typically a misconception of how our progressive tax system works. What many people don’t realize is that our federal income tax brackets reflect marginal rates, not a rate that is applied to your entire income. Here’s a quick example based on current income tax rates…

For a married couple filing jointly in 2008, the 10% tax bracket covers income from $0 to $16,050. From $16,050 to $65,100 the tax rate is 15%. And from $65,100 to $131,450 the tax rate is 25%. A couple with a taxable income of $100k will be in the 25% tax bracket, but they won’t have to pay 25% in federal income taxes on the full amount. Rather, they’ll pay just 10% on the first $16,050, 15% on the next $49,050, and 25% on the last $34,900. This works out to $17,687.50, or an effective rate of just under 18%.

Of course, you should still try to minimize your taxable income as much as possible by contributing to retirement accounts, taking advantage of perks like a flexible spending account (FSA), and maximizing your income tax deductions. But, as you can see from the numbers above, you have nothing to fear from earning a bit more money and finding yourself in a higher tax bracket. Moving to a higher tax bracket will never cause you to take home less money than if your income were lower.

Published on December 4th, 2008
Modified on January 9th, 2012 - 29 Comments
Filed under: Taxes

About the author: is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!

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29 Responses to “How do Federal Income Tax Brackets Work?”

  1. 1
    j Says:

    Wow! A wonderfully simple explanation to an awkwardly complex tax system. j

  2. 2
    gm Says:

    Good explanation. I have often argued with people who claim that they don’t want to just go over a certain figure in earnings because the net tax effect is a loss in income.

    But in a progressive situation like you explained that will never happen. Of course it helps to maximize pre-tax deductions too.

  3. 3
    FlatGreg Says:

    Don’t forget that those rates apply to your taxable income, not your gross income. Subtract all those deductions and your effective tax rate is even lower.

  4. 4
    SanDance Says:

    “Moving to a higher tax bracket will never cause you to take home less money than if your income were lower.”

    Until you hit that ceiling and the Alternative Minimum Tax (AMT) kicks in. Not a problem for me yet, but know others who never considered themselves ‘rich’ and were blindsided by this expense come tax time.

  5. 5
    Mr. ToughMoneyLove Says:

    I like this topic. If you want to take an interesting ride through tax history, go back and look at the marginal rates that baby boomers like me were paying in the ’70’s and ’80’s before Reagan and then Clinton lowered them. Unfortunately, they may be heading up again.

  6. 6
    nickel Says:

    SanDance: Yes and no. The AMT is a funny thing. We got hit by it last year, and will likely face it again this year. As it turns out, we really have two tax systems, and you are required by law to pay whichever one results in higher taxes. Technically, we’re all subject to the AMT, but for most people the AMT ends up being lower than you ‘normal’ progressive tax bill, so you pay that one instead of the AMT. Anyway, the AMT is another topic entirely (and I’ve written about it in the past). I will tell you this, however… We paid the AMT in 2007 but we still came out well ahead of where we were in 2006 because we made a lot more money. As much as it sucks, the AMT is the sort of thing you should aspire to, because it means you’ll be generating much more income.

  7. 7
    Jim Says:

    AMT isn’t nearly as bad as people seem to think. The only way you hit AMT is if you have certain large deductions and high income. Most people never come close to it.
    ONly 3% of people paid AMT in 2005 (newest numbers I found). >90% of the people paying AMT make over $100k. The average tax bill for people paying AMT was $4350. The average tax bill for normal returns was over $10k. THe people paying AMT are paying much less effective tax (as a %) than the rest of us.

    Jim

  8. 8
    Tim Says:

    @nickel: shame on you, we shouldn’t aspire to do any such thing. we’ll miss out on Obama’s tax credit then. we all know that being middle class is the american dream, so there shouldn’t be any aspiring to become wealthier. shame on you. shame on you for making more money and not giving me any of it either.

  9. 9
    Tim Says:

    @Jim, the low % people paying AMT is due to the AMT relief Act which increased qualifying income levels.

  10. 10
    nickel Says:

    Tim: We already missed out on Bush’s stimulus check, so why should this be any different? Oh, and if you got a stimulus check earlier this year, then we did give you some money. :)

    Also, the only reason they need to patch the AMT every year is because they didn’t have the foresight to index it to inflation when they created it.

  11. 11
    Tim Says:

    @nickel: I in fact got two stimulus checks, although the IRS decided they wanted one of them back…and since i earned enough, i was actually paying myself back, not you…so you still owe me money. and there is still no reason for me to aspire to earn more since you need to redistribute your wealth to me.

    yes, i know about the AMT patch. we have patches for everything now.

  12. 12
    Danielle Says:

    I had lots of fun explaining this to my younger siblings a few years back (when they were in about 4th or 5th grade). I don’t know why more people don’t talk about stuff like this with their kids. My parents sure didn’t.

  13. 13
    Rick Barrett Says:

    It is interesting how frequent this misconception comes up. Assuming you are married and both work… there is a peak in the taxes at about $204K then as you earn more money. Then your tax rate actually goes down. This is due to Social security tax. Which is 6.2% up to $102,000 this year. And not only do you pay it your employer pays another 6.2%. So if you get a raise after making the SSI limit you get to keep that 6.2% AND BECAUSE YOUR EMPLOYER DOESN’T HAVE TO MATCH IT…you may actually be able to get all or part of that money, too. So you have opportunity at least in theory to get richer…. and pay less in taxes…. when viewed as actual tax rate… So all the income above $102K is an even better deal than the low rates on what you earn up to $102K.

  14. 14
    Jim Says:

    They’ve been regularly raising the exemptions for AMT. Since they’re raising it there hasn’t been a problem. They should just pass a law to build an automatic increase in the exemption so that it will be fixed long term. From 2005 to 2008 they raised the exemption over 5% a year which is better than peoples rate of pay has gone up.

    Most of the fear about AMT is what might happen *if* they didn’t raise the exemption.

    Jim

  15. 15
    walt reyer Says:

    I’m going to retire in Dec 2009. I will recieve severance
    pay which will put me in the 33% tax bracket by $23,000. Would it make sense to work until Jan 1st and recieve the severance

    My wife and I file jointly. She makes $25,000, I make $131,000 would we be better off to file seperatly?

    Thanks!

  16. 16
    Jason Says:

    Just received a raise that puts me in the next bracket. This simple explanation was great and put me at ease! Thanks! :)

  17. 17
    don goddard Says:

    what is rhe standard deduction for born before jan. 2,1944 for the tax year 2009.last year it was 6,500.

  18. 18
    Linda Says:

    Do you use adjusted income or gross income when determining your tax bracket?

  19. 19
    rob Says:

    This President continually picks on the poor, disabled, and retired elderly.

    His administration raises the bottom tax rate by 50% (10-15%) while raising the top bracket about 15%.

    Over and over it’s the same story with this guy.

    Just wanted to say it was not nice knowing you Mr. Obama. You are probably the worst president in history, and I feel like an idiot for having voted for you. Come next election, you are gone no matter who your opponent is, that’s who I’ll be voting for.

  20. 20
    Howard Says:

    Tax rates are not at all marginal when it comes to long term capital gains. Stay within the 15% bracket and you pay nothing. One cent over and you pay 15%. Could be a big deal if you’re selling a family home you didn’t live in recently.

  21. 21
    Ben Says:

    Rob, you are ignorant, stop spewing misinformation. I don’t understand how you can stand the tate of the shit that is pouring out of your mouth. President Obama was unable to do anything related to taxes due to the republican controlled congress. Judge him by the only things he has direct control over like the military that he is
    commander and chief of… You know the one that caught Bin Laden after the same military controlled by Bush spent $285 billion and 1196 American troop lives Failing to do so(that’s only the actual war in Afghanistan that only happened because of the illegitimate war bush started in Iraq allowing Al Qaeda to gain enough momentum and funding to cause trouble to begin with)

  22. 22
    jeff Says:

    So using the above info..

    If I make 65,200 this year.

    65,100 will be taxed at 15%
    and
    100 will be taxed at 25%

    ?????

  23. 23
    Chris Says:

    Jeff –

    This is an old thread, and the tax brackets change every year. Based on expected brackets for 2012, your taxable $65,200 (assuming that’s after deductions/exemptions) will be taxed as such:

    The first $17,400 of your income is taxed at 10% ($1,740). Then your remaining $47,800 is taxed at 15% ($7,170).

    For a total tax bill of $8,910, or 13.67% overall of your taxable income.

    Chris

  24. 24
    Robert Says:

    Stop pay tax

  25. 25
    Dan Says:

    Jeff,

    You forget about the standard deduction in your example. In your above example, there would be a refund of $2290 with a zero effective tax rate using the standard deduction for married filing jointly (the brackets you used) of $11,200 for 2012, which is why 49% of Americans have no Federal tax liability at all.

  26. 26
    Mike Says:

    Dan,

    My understanding is that the standard deduction is applied to the taxable amount, not the final tax amount. So assuming married-filing-jointly, 65200 gross with the 11200 std deduction and 7600 personal exemptions (Jeff and spouse) would yield a taxable 46400, tax of 6090, and effective rate of 9.34%. He is not part of the 47-49%.

    A couple would have to gross equal to or under their std deduction plus personal and dependent exemptions in order to be part of that 47-49 group.

    That is of course, if I’m understanding the personal exemptions correctly.

  27. 27
    D Scott Brown Says:

    Thanks for the always clear presentations regarding taxes, exemptions, deductions, etc. Here’s a question I’d like to see you tackle: Should my wife and I, now 69 and 68 and retired for 15 months, convert a significant portion of our “traditional” IRAs to Roth IRAs? We think it wise to do so, such as over the next 3 to 5 years, if allowable.

  28. 28
    William L. Says:

    Scott — If tax rates rise to 50% over the next few years you should convert those traditional IRAs to ROTHs ASAP !!

  29. 29
    Mario K Says:

    Scott, I have not read anything projecting a 50% Federal income tax rise.
    Your decision on conversion to Roth may be based on several factors. One of the most important factors is your projection of your income tax bracket in the year of your projected conversion compared to the income tax bracket of projected withdrawal of the funds without a conversion.
    To put it simply:
    If you expect your income to decrease, don’t convert till your income decreases.
    If you expect your income to keep decreasing, then the income free earnings on a Roth will probably not equal the immediate payment of the tax in a higher tax bracket and the decreased income on your after tax remainder.
    You may consider converting only small amounts each year, being careful that your conversion does not place the converted funds in a higher bracket.

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