Friday, April 19, 2013

Tax Brackets and Tax Rates

Do you know what your tax rate is? 

That’s a trick question as you really have two tax rates:  1) your Marginal Tax Rate and 2) your Effective Tax Rate.

To understand each, you need to understand our tax system. The U.S. tax system is not based on a single tax rate, but rather a series of tax rates known as tax brackets based on your amount of taxable income. Everyone pays the same tax rates at each income level, and the more taxable income you have, the higher your tax rate.

The premise behind this tax system is that those with a higher ability to pay (higher income) carry a greater tax burden than those with a lower ability to pay (lower income).

Now let’s take a look below at the 2013 tax brackets for someone filing as “Married Filing Jointly.” (This is referred to as your tax filing status. We won’t go into detail here as this can be an entirely separate topic.)

Taxable Income
Tax Rate
Under $17,850
$17,850 – $72,500
$72,500 – $146,400
$146,400 – $223,050
$223,050 – $398,350
$398,350 – $450,000
Over $450,000

In our hypothetical example, Calvin and Grace Coolidge are Married Filing Jointly with a taxable income of $150,000.

Based on the chart above, their taxable income puts them just in the 28% tax bracket (shaded). This is their Marginal Tax Rate. In other words, if Calvin was given a raise of $1, this additional $1 of income would be taxed at 28%. (He would pay 28¢ in taxes and keep 72¢ in income.)

While their Marginal Tax Rate is 28%, not all of their taxable income is taxed at 28%. Here’s how their tax brackets would be calculated.

For the taxable income over …
But not more than …
The tax rate is …
And the tax is …
Income taxed at this rate …
+ 10%
+ 15%
+ 25%
+ 28%


So in the example above, Calvin and Grace paid a total of $29,465.50 in taxes on taxable income of $150,000. If we divide the total taxes paid by the total taxable income we get 19.64% (25,662.50/150,000.00 = 0.1964 or 19.64%). This is their Effective Tax Rate. In other words, if they paid flat tax rates on all of their taxable income, it would have equaled 19.64%.

In our example, the couple has a Marginal Tax Rate of 28% and an Effective Tax Rate of 19.64%. This tells us that any additional income would be taxed at a minimum of 28%, and that overall they are paying tax of 19.64% on all their income.

If you have more questions about either your Effective Tax Rate1 or Marginal Tax Rate2, or how they impact your financial decisions, please feel free to contact our office. 

Let’s take our hypothetical example one step further. Assume that Calvin and Grace took advantage of every credit, exemption and deduction allowable and arrived at the taxable income of $150,000.00 noted above. Then their tax liability would be $29,465.50 and they can do nothing to change that.

Whether they get a tax refund or make a tax payment depends only on if they had too much or too little in taxes withheld from their income. If, for example, they had $31,000.00 withheld, then when they file their 2013 taxes they will be entitled to a refund of $1,534.50 (31,000.00 – 29,465.50 = 1,554.50). If, however, they only had $28,000.00 withheld, then when they file their 2013 taxes they will owe $1,465.50 (28,000.00 – 29,465.50 = -1,465.50).

The key, then, to tax planning is to understand these concepts and to maximize every credit, exemption and deduction allowable. At Kemp & Associates, tax planning is included in all of our financial planning. For more information on how we can help you plan for retirement, contact us today.

Image Credit: Images_of_Money

"Effective Tax Rate Calculation" eHow Money, December 3, 2012;

"Update: 2013 Federal Income Tax Brackets and Marginal Rates" Forbes, January5, 2013;

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