As your income grows and you become more successful in life, you’ll often find that you are paying more in taxes. In the United States, there is a progressive tax system. As you move up in income your tax rate also rises on the additional income, with the theory being that people who are making more money can also afford to contribute more back to society.
Currently, there are seven tax brackets ranging from a low of 10% and rising to 37% at much higher income levels. These tax rates apply to taxable income, which is basically income less deductions. As an example, currently an unmarried individual who has a taxable income of $9,700 would be in the lowest tax bracket and pay $970, or 10%, in taxes. At the highest level an unmarried taxpayer who makes over $510,301 in taxable income would pay a 37% tax on all income over that level.
If you are interested in how to find your tax bracket, check out an easy to use tax calculator. This tool can help you with your tax planning.
Marginal Tax Rates
In the United States there is a graduated, or progressive, tax rate system. As your income rises so do the marginal tax rates that apply to new income levels. The initial dollars of taxable income are taxed at the lowest bracket rate while the last taxable dollars you make are assessed at the higher applicable bracket rate.
Let’s take a simple example where a single taxpayer has $60,000 in taxable income. Per the tax bracket schedule, this level of taxable income crosses three tax brackets. The first $9,700 in income is taxed at the lowest bracket rate of 10%. From the second bracket, income from $9,701 to $39,475 is taxed at 12%. For the taxable income from $39,476 to $60,000 you would apply the third bracket percentage of 22%.
Actual Tax Rates
If we continue with the example above, we find that individual has a total tax obligation across the three brackets of $9,058 ($970 plus $3,573 plus $4,515). This gives an actual tax rate of 15.1% for the $60,000 in taxable income. As you can see while 22% represents the top applicable marginal tax rate in this example, the effective tax rate on taxable income is much lower because of the progressive tax system.
How Higher Brackets May Affect Benefits
In general, making more money will give you more take home pay even if you move to higher brackets but there can be some exceptions. At times an increase in wages may increase your income but at the same time trip a threshold for eligibility for a social benefits program. For example, an individual who currently gets SNAP benefits or is part of a state health insurance program could see their benefits lowered or eliminated because of the individual’s new higher income.
While changing tax brackets can result in a higher marginal rate of income tax being paid, the highest rate is not applied to all of your income. Under the progressive tax schedule, you only pay the highest applicable tax rate on the income from within that higher bracket.