I believe that tax brackets can be one of the most confusing items in personal finance (thank you IRS). We have different brackets for different people, single, married, head of household. We have standard deductions, itemized deductions and all of these forms you need to complete.
There are 2 different kinds of tax rates to think about, and we’re just going to focus on federal taxes on ordinary income for now. Your marginal tax rate and your effective tax rate.
Your marginal tax rate is what your next incremental dollar of income will be taxed or, or you could also look at it as the highest rate you will pay in taxes. Because the tax rate is progressive, the more money you make the higher percentage you pay. BUT, it doesn’t mean if you go into another marginal bracket, that every dollar you make gets taxed at that new higher rate.
In order words you pay 0% tax on the amount of your deduction, whether its the standard deduction or the total or your itemized deduction (you take the higher of the 2). You pay 10% in tax on the next amount of income, 12% on the next chunk, 22%, then 24%, then 32%, then you get up to 37%.
Your effective tax rate is how much you pay in tax as a percentage of your income. Spoiler alert, its lower than the marginal rate you fall into.
Let’s take a married couple who made $600,000 in 2022. Their marginal tax rate is 37%, but their effective tax rate is. .
Don’t let a small raise or making a little bit more scare you because you’re worried about going into the higher tax bracket. Even at 37%, that’s 63% in your pocket!
Conversely, when you’re looking for tax deductions, they go against your marginal bracket. So if you’re in the 37% marginal rate and your accountant is asking to track expenses. Every dollar of deduction you find saves you 37 cents on the dollar!
The opinions voiced in this article are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.
Schadel Financial Group and LPL Financial do not offer tax advice or services.