There are only three constants in life: Death, taxes, and folks having no idea what tax brackets really mean. Why do I say this? Because I regularly run into otherwise well educated people who think that because they are in the 24% tax bracket that they pay Uncle Sam 24% of their income in taxes. But that’s not true. Lets look at the 2019 federal tax brackets.
2019 federal tax brackets:
|Tax rate||Single||Married filing jointly|
|37%||$510,301 and more||$612,351 and more|
Sally is a new graduate working for a multi-doctor practice in Phoenix. She is single and is making $84,000 / year. Sally has student loans, but because she makes more then $80,000 they are not tax-deductible. She has no other deductible expenses (i.e. a mortgage). If we look at the chart above, we see that she is in the “22% bracket.” A lot of folks seem to think that her federal taxes would be $18,480 ($84,000 * 0.24) but taxes don’t work like that. In reality her federal taxes end up being $14,276 which is an effective (marginal) tax rate of ~17%. How is this possible?
Tax Bracket Vs. Tax Rate
Say for a moment you earned $9,700 this year. This put you at the top of the 10% tax bracket and you would pay a 10% on the entire amount ($970). Next year you are expecting a $100 raise. This would put you in the 12% tax bracket; however, your taxes are $982 NOT $1,176 ($9,800 *.12) The way federal taxes in the US work, you would pay 10% on the first $9,700 and 12% on just the extra $100. It’s a progressive tax system where you pay the tax rate for the money earned in each bracket. Otherwise, the tax system would be a disincentive to working harder.
Lets look at sally again for a moment. She earned $84,000 this year which would put her in “24% bracket.” To calculate her actual taxes you need to calculate her tax in each of the brackets and add it up. So for example she would pay 10% on the first $9,700 ($970) and then 12% on the next $29,775 ($3,573) and 22% on the last $44,275 ($9,733).
- 10% on first $9,700 = $970
- 12% on next $29,755 = $3,573
- 22% on $44,275 = $9,733
Thus she would pay $14,276 on $84,000 of income. This would represent an effective tax rate of ~17%. Want to figure out your effective tax rate but don’t want to do all the calculations? This website has a very nice interactive graphic for calculating effective tax rate. Just slide your cursor along the graph to see the effective tax rate for any income. While its normal to complain about taxes, now your can calculate exactly what you are complaining about!