Understanding Income Tax Brackets

It’s a bit more complicated than your NCAA tournament bracket.

There’s a good reason so many people seek professional help with preparing their income taxes. It’s because the tax is complicated, and at the heart of the convoluted system are federal income tax brackets.

Federal income tax rates are divided into seven brackets that are based on income and range from 10% to 39.6%. If that was the whole story, understanding federal income tax brackets would be a breeze –but that’s not the whole story.

How Many Tax Brackets Are There?

Let’s start with some scary numbers: Your income will be taxed at more than one of 28 possible tax rates. Now, take a deep breath as we start to unpack the whole thing.

There are seven federal income tax brackets in 2016: 10%, 15%, 25%, 28%, 33%, 35% and 39.6%. And there are four different filing statuses:

  • Single: This applies to unmarried people.
  • Married filing jointly: For married couples who are combining their income on a single tax return.
  • Married filing separately: Married couples who are each filing their own federal income tax return.
  • Head of household: This applies to individuals who are considered single for filing purposes and provide more than half the support for a child and are able to claim that child as an exemption.

There you have it, seven tax brackets with different tax rates multiplied by four filing statues equals 28 possibilities. You’re not subject to all those possibilities, because you can only file your return using one status. However, it’s possible that you will be taxed at up to seven different rates, depending on your income.

Federal Income Tax Name Games

Much of the confusion about taxes comes from the terms used to discuss them.

Tax brackets: These are most easily understood when you recognize them for what they are. Each tax bracket includes two amounts: a base amount and a ceiling amount. Any income that falls in between those two numbers is taxed at that bracket’s rate.

Rate Single Married Jointly Married Separate Head of Household
10% Up to $9,275 Up to $18,550 Up to $9,275 Up to $13,250
15% $9,276 – $37,650 $18,551 – $75,300 $9,276 – $37,650 $13,251 – $50,400
25% $37,651 – $91,150 $75,301 – $151,900 $37,651 – $75,950 $50,401 – $130,150
28% $91,151 – $190,150 $151,901 – $231,450 $75,951 – $115,725 $130,151 – $210,800
33% $190,151 – $413,350 $231,451 – $413,350 $115,726 – $206,675 $210,801 – $413,350
35% $413,351 – $415,050 $413,351 – $466,950 $206,676 – $233,475 $413,351 – $441,000
39.6% More than $415,050 More than $466,950 More than $233,475 More than $441,000

Marginal tax rate: When you hear people say they’re in the 28% tax bracket, they are referring to their marginal tax rate. Your marginal tax is based on your “last dollar” of income. That means if you are single and earned $200,000, your marginal tax rate would be 33%.

Effective tax rate: This is the actual tax rate you pay on all your income. For example, if you file your return as married filing jointly and have a combined income of $200,000, your effective rate won’t be more than 22%, even though you are in the 28% tax bracket. Why? Keep reading.

How It All Works

The reason your marginal tax rate (tax bracket) is higher than your effective tax rate is because your income is taxed at different rates along the way.

Let’s say you’re a single taxpayer who earns $35,000 per year. The first $9,275 of your income is taxed at 10%, and the remaining $25,725 is taxed at 15%. While $35,000 falls into the 15% tax bracket, your effective tax rate is actually 13.7%. The higher your income, the more tax brackets you pass through to arrive at your effective tax rate.

Fortunately, you don’t have to determine your effective tax rate using a calculator or spreadsheet, since tax software will do the calculations for you. You can also look up your tax due in the IRS tax tables that come with your Form 1040 instructions; the tables show the tax due for incomes between $3,000 and $99,000, with a worksheet to determine your effective tax rate if your income is above $100,000.

Knowing both your marginal and effective tax rates from the charts is only the end of the tax bracket story and not the final word on the size of your tax bill. The actual amount of taxes you owe can only be determined by completing a tax return, which will take into account all deductions, exemptions, and eligible credits. But that’s another story altogether.