Do you know your tax bracket? This how tax bracket works.

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The term “tax bracket” refers to the highest tax rate charged on your income. Under the federal income tax system, different rates apply to different portions of your income. So people in, say, the 25 percent tax bracket don’t actually pay 25 percent of their income in taxes; rather, the last dollar they earn is taxed at 25 percent.

Progressive system, marginal rates
The federal income tax is progressive, meaning that tax rates increase as your taxable income goes up. As of publication, for example, income was taxed at seven rates: 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, 35 percent and 39.6 percent. These are marginal rates, meaning that each rate applies only to a specific slice of income rather than to your total income. The rate that applies to the top slice of your income is your tax bracket.

A simplified example of brackets
For a simple example of how progressive taxation works, say the government has three marginal rates, set up like this:

10 percent: $0 to $20,000
20 percent: $20,001 to $50,000
30 percent: $50,001 and above
Now say your taxable income is $75,000, which puts you in the 30 percent bracket. The first $20,000 of that would be taxed at 10 percent, or $2,000. The next $30,000 would be taxed at 20 percent, or $6,000. The final $25,000 of your income is taxed at 30 percent, or $7,500. Your total tax: $15,500. Even though you’re in the 30 percent bracket, you actually pay only about 20.7 percent of your income in taxes.

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Taxable income is what matters
Tax brackets apply only to your taxable income—that is, your total income minus all your adjustments, exemptions and deductions. For example, a married couple with two dependent children could reduce their taxable income by $28,200 just by taking the personal exemptions and standard deduction to which all taxpayers are entitled, as of publication. This alone might be enough to drop the family into a lower tax bracket.

Adjusting tax bracket parameters
Congress decides how many tax brackets there are and what the rates will be for each bracket. It’s the Internal Revenue Service’s job to adjust income thresholds to keep pace with inflation. For example, in the 2014 tax year, for a married couple filing a joint return, the 10 percent bracket applied to the first $18,150 in taxable income. The 15 percent bracket went up to $73,800. The 25 percent bracket went up to $148,850, and so on. The top rate, 39.6 percent, applied when taxable income topped $457,600. For single taxpayers, the thresholds were lower. The IRS announces the tax brackets for each year before that year begins.