How Tax Brackets Work


The amount of taxes you pay is lower than what your tax bracket would suggest. Jeffrey Hamilton/Getty Images

You might be on your last dollar, but it's not always a reason to sing the blues. In fact, in the strange world of the U.S. tax code, your last dollar could actually bump you up into a higher tax bracket. Put on your shades, grab your guitar, and read on to understand why.

A tax bracket is a range of incomes taxed at a specific rate. Tax brackets are components of a progressive income tax system, in which taxes increase progressively as your income increases. The idea is that high-income taxpayers can shoulder the burden of a high tax rate. Low-income taxpayers pay less because they can't afford to pay high taxes.

For example, there are seven tax brackets in the current U.S. tax code. The Tax Cuts and Jobs Act lowered the rates for five of them for the 2018 tax year. The new 2018 rates are as follows:

  • 10 percent
  • 12 percent
  • 22 percent
  • 24 percent
  • 32 percent
  • 35 percent
  • 37 percent

The Tax Cuts and Jobs Act also lowered the taxable income range for each 2018 bracket. This is good news for a lot of taxpayers because they will fall into a lower bracket on their 2018 returns. The new taxable income for a single person filing his or her 2018 return will be broken down as follows:

  • 10 percent on income up to $9,525
  • 12 percent on income between $9,526 and $38,700
  • 22 percent on income between $38,701 and $82,500
  • 24 percent on income between $82,501 and $157,500
  • 32 percent on income between $157,501 and $200,000
  • 35 percent on income between $200,001 to $500,000
  • 37 percent on any remaining income over $500,000

­Your tax bracket and your marginal tax rate are similar but not exactly the same thing. A marginal tax rate is the tax paid on an additional dollar of income. Those earning the lowest income are in the lowest marginal tax rate bracket, while high earners are in the highest marginal rate tax bracket. However, the marginal tax bracket in which an individual falls does not determine how the entire income is taxed [source: Investopedia].

If you earned $70,000 and are filing as a single person for instance, you'd be in the 22 percent tax bracket but your income will be taxed at three separate marginal tax rates. You'll see an example of this later in this article. You'll also find out how to find your U.S. tax bracket and learn a little about the history of tax brackets in the United States.

Finding Your Tax Bracket

Finding your tax bracket is actually pretty easy. First you need to know your taxable income. Taxable income is your adjusted gross income (AGI) minus your standard or itemized deductions.

Let's put this into a working example we'll use throughout the section:

Karen's taxable income is $70,000.

Next you need to know your filing status:

  • Single
  • Head of household
  • Married filing jointly or Qualifying widow(er)
  • Married filing separately

Karen is single.

Next is the tax bracket. As we explained earlier, for the 2018 tax year, there are seven tax brackets for each filing status. Since Karen is filing single, she would look at IRS Schedule X, which lists the tax rates for people who file single. They are:

  • $0 to $9,525 (taxed at 10 percent)
  • $9,526 to $38,700 (taxed at 12 percent)
  • $38,701 to $82,500 (taxed at 22 percent)
  • $82,501 to $157,500 (taxed at 24 percent)
  • $157,501 to $200,000 (taxed at 32 percent)
  • $200,001 to $500,000 (taxed at 35 percent)
  • $500,001 or more (taxed at 37 percent) [source: U.S. Tax Center]

Karen's taxable income of $70,000 falls into the third tax bracket of $38,701-$82,500, so she has a tax rate of 22 percent. At first glance, Karen thinks that her $70,000 will be taxed at 22 percent. Fortunately for her, that's not how the U.S. tax code works.

Karen's income will be taxed as it progresses through the tax brackets. So, her first $9,525 is taxed at a rate of 10 percent. Her income that falls in the second bracket will be taxed at 12 percent. Her "last dollar" lands in the third bracket. Only the portion of her income that falls into that third bracket will be taxed at 22 percent. Here are the calculations:

First Bracket: $9,525 x 0.10 = $952

Second Bracket: ($38,700 - $9,525) x 0.12 = $3,501

Third Bracket: ($70,000 taxable income - $38,700) x 0.22 = $6,886

Total Tax: $952 + $3,501 + $6,886 = $11,339

A second example: Let's say Raoul and Gretchen are married. Their combined taxable income is $325,000. They file a joint tax return, so they consult IRS Schedule Y-1:

Married filing jointly

  • $0 to $19,050 (taxed at 10 percent)
  • $19,051 to $77,400 (taxed at 12 percent)
  • $77,401 to $165,000 (taxed at 22 percent)
  • $165,001 to $315,000 (taxed at 24 percent)
  • $315,001 to $400,000 (taxed at 24 percent)
  • $400,001 to $600,000 (taxed at 35 percent)
  • Over $600,000 (taxed at 37 percent) [source: Rose].

Raoul and Gretchen's taxable income of $325,000 falls into the fifth income tax bracket. Here are the calculations for their taxes:

First Bracket: $19,050 x 0.10 = $1,905

Second Bracket: ($77,400 - $19,050) x 0.15 = $8,752

Third Bracket: ($165,000 - $77,400) x 0.22 = $19,272

Fourth Bracket: ($315,000 - $165,000) x 0.24 = $36,000

Fifth Bracket: ($325,000-$315,000) x 0.32 = $3,200

Total Tax: $1,905 + $8,752 + $19,272 + $36,000 + $3,200 = $69,129

Raoul and Gretchen's taxable income is about $10,000 over the fourth bracket's upper limit. That final amount is taxed at 32 percent, or 8 percent higher than the next lowest rate. To stay out of the fifth bracket, they might consider looking for additional deductions to decrease their taxable income.

A $69,129 tax bill seems like quite a hit. But imagine being in a 94 percent tax bracket. It's happened to U.S. citizens — in living memory. Read on to learn about the history of income tax brackets.

Tax Bracket History

U.S. President George W. Bush holds an Internal Revenue Service (IRS) letter that details the Economic Stimulus Act of 2008. Even the president pays taxes.
U.S. President George W. Bush holds an Internal Revenue Service (IRS) letter that details the Economic Stimulus Act of 2008. Even the president pays taxes.
Jim Watson/AFP/Getty Images

Colonial and early U.S. taxes went through various changes until the first income tax was established by the Revenue Act of 1861. The purpose of this income tax was to help the Union raise money to fight the Civil War against the Confederacy. This income tax affected incomes of $800 and up at a rate of 3 percent.

The first tax brackets came about in 1862. The lower tax bracket was 3 percent for income up to $10,000; the higher tax bracket was 5 percent for income over $10,000. In 1872, this income tax was repealed. Since the Civil War ended, the government no longer needed the money.

The U.S. Constitution gave the federal government the power to levy taxes "in proportion to each State's population" [source: U.S. Department of the Treasury]. When the federal government established an income tax in the 1890s, the Supreme Court declared the tax unconstitutional, because it disregarded state populations.

In 1913, the 16th Amendment to the Constitution gave the government the power to levy an income tax regardless of state population. The federal income tax has been in place ever since.

Here are some important dates in the history of the federal income tax and its tax brackets.

  • 1913: Tax brackets range from 1 percent on income of $0-$20,000 to 7 percent on income of $500,000 and higher.
  • 1916: Revenue Act increases rates. Tax brackets range from 2 percent to 15 percent.
  • 1917: War Revenue Act of 1917 increases rates. Tax brackets range from 2 percent on income of $0-$2,000 to 67 percent on income of $2 million and higher.
  • 1920s: Tax rates are cut because the economy is doing well. The highest marginal rate decreases to 25 percent.
  • 1930s: Big increases because of the Great Depression. Lowest rate is 4 percent. Highest rate is 79 percent. Income of $90,000-$100,000 is taxed at 59 percent. In 1933, there are 55 tax brackets, mostly in 1 percent increments.
  • World War II: Great tax increases to fund the war. The lowest rate in 1944 is 23 percent, for income of $2,000 or less. The highest rate is 94 percent for income of $200,000 or more.
  • 1981: Economic Recovery Tax Cut of 1981 lowers tax rates. Highest tax rate drops from 70 percent to 50 percent.
  • 1986: Tax Reform Act of 1986 reduces rates further and cuts the number of brackets. For the 1986 tax year there are 15 tax brackets. For 1987, there are five [source: The Tax Foundation].
  • 2013: American Taxpayer Relief Act of 2012 increases the highest income tax rate to 39.6 percent and also establishes seven tax brackets.
  • 2018: The Tax Cuts and Jobs Act kept seven tax brackets but lowered the rates for five of them. The highest tax rate is also lowered to 37 percent.

If you'd like to know more about tax brackets and related topics, you can follow the links on the next page.

Last editorial update on Jan 17, 2019 01:45:51 pm.

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Sources

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