How to Figure Out Your Federal Income Tax Bracket

Each April, federal income tax returns are due for individuals. You fill out tax forms or pay someone else to do it for you.

Once you’re done filling out the forms, you find out whether you get a tax refund or have to make a tax payment.

But what determines that amount of taxes that you owe?

While there are many calculations and tax terms involved in the process, the majority of the calculation usually comes down to your taxable income and tax brackets.

Sadly, many people think they understand how tax brackets work but are mistaken.

And:

If you don’t understand how tax brackets really work, you may give up additional income for fear of falling into the next tax bracket.

Here’s what you need to know about federal income tax brackets and how they really work.

As always, make sure you consult a tax professional for anything regarding your specific income tax situation.

What Are Tax Brackets?

Tax brackets are just a simple way of showing you how to calculate the amount of federal income tax you owe.

First, you figure out your taxable income. Then, you can preliminarily calculate how much tax you owe using the tax brackets.

Keep in mind, figuring out the tax based on your taxable income isn’t the last step of a tax return.

There are still steps to take after calculating how much tax you owe, such as subtracting tax credits, that can lower your tax bill.

Let’s take a look at the current federal income tax brackets for the tax year 2018.

Then, we’ll explain exactly how they work, including examples.

What Are The Current Federal Income Tax Brackets?

The below table shows the current federal income tax brackets for the tax year 2018.

You’ll file your 2018 tax return in early 2019 unless you file an extension for time to file.

Federal Income Tax Brackets - 2018

Rate Single or Married Filing Separately Married Filing Jointly Heads of Household
For taxable income over the below amounts
10% $0 $0 $0
12% $9,525 $19,050 $13,600
22% $38,700 $77,400 $51,800
24% $82,500 $165,000 $82,500
32% $157,500 $315,000 $157,500
35% $200,000 $400,000 $200,000
37% $500,000 $600,000 $500,000

The common mistake

Now:

Most people mistakenly believe that they pay tax on all of their taxable income using the tax rate of the bracket they fall in.

This is NOT how the federal income tax system works.

But, here’s an example of how this works based on this false belief.

Incorrect tax bracket calculation

John Smith is a single person. His taxable income was $38,600 in 2018. Based on his tax bracket, he’d pay 12% on his taxable income. This results in a tax of $4,632 before tax credits.

But what if John Smith got a $200 bonus at the end of the year and earned $38,800 in taxable income.

In this case, according to this false belief, John would now be in the 22% tax bracket and pay $8,536 in taxes before tax credits.

How Federal Income Tax Brackets Really Work

Fortunately, federal income taxes don’t work this way.

Instead, the United States federal income tax system is a marginal income tax system.

This means:

You only pay the higher tax rates on additional income earned in the next bracket, not on every dollar you earned.

This concept is confusing for a lot of people, so here’s a detailed example of how marginal income taxes are calculated using the earlier John Smith example.

How marginal income tax brackets apply

In the first portion, John Smith earned $38,600 in taxable income in 2018. Using the tax bracket chart above, John would calculate a 10% tax on taxable income between $0 and $9,525 and 12% tax on income between $9,526 and $38,700.

Essentially, John would calculate $952.50 tax owed in the 10% bracket and $3,489 tax owed in the 12% bracket for a total federal income tax of $4,441.50.

This is $190.50 less than the incorrect method of simply selecting the bracket your income falls into and using that to calculate your tax.

It’s even better when you consider John Smith’s higher taxable income with the $200 bonus.

Rather than taxing all of his income at 22%, John would only have to pay 22% tax on the $100 of the bonus that puts him above the $38,700 and into the 22% tax bracket.

In this example, John would calculate a tax of $4,475.50 with the bonus, $4,060.50 less than using the incorrect method.

How to Determine Your Marginal Income Tax Bracket

Now you know that tax brackets work by taxing each additional dollar of income at the higher rate. You don’t use your total income to calculate tax at the higher rate.

But how do you figure out what tax bracket your marginal income falls into?

All you have to do to figure out which tax bracket you fall in is calculate your taxable income and compare it to the tax bracket chart.

You need to make sure you use the correct column based on your filing status, but it’s pretty easy to do.

Let’s say you’ll file a married filing jointly tax return and your taxable income is $254,304. Your marginal income tax bracket would be 24%.

This bracket is for taxable income above $165,000 but less than $315,000. Each additional dollar you earn will be taxed at 24% for federal income tax until your income exceeds $315,000.

If you exceed $315,000, then your additional tax for every dollar will be taxed at 32%.

Knowing which marginal income tax bracket can be useful if you have to make estimated income tax payments.

Ways to Drop to Lower Your Tax Bracket

Thankfully, our federal income tax system offers many ways you can lower which income tax bracket you fall into. Essentially, you can lower your tax bracket by reducing your income or increasing your deductions.

The following are some of the ways you can reduce your taxable income:

  • Earn less income
  • Contribute to pre-tax retirement accounts such as a 401(k)
  • Pay for pre-tax benefits such as health insurance
  • Contribute to a tax-deductible IRA and deduct the contributions from your income
  • Have a qualified business that offers the qualified business income deduction
  • Take the standard deduction
    • OR take itemized deductions in place of the standard deduction which includes things such as:
      • Medical and dental expenses above 7.5% of AGI
      • State and local taxes up to $10,000
      • Home mortgage interest up to certain limits
      • Gifts to charity
      • Casualty and theft losses from a federally declared disaster

Calculate Your Effective Federal Income Tax Rate

The marginal income tax bracket you fall into is useful so you can know exactly how much tax you’ll have to pay on each additional dollar of income you earn.

But there’s another tax rate you should know.

Your effective federal income tax rate is a better indicator of how much income tax you pay each year.

To find this number, take the total tax calculated on line 15 of Form 1040. Then, divide it by your total income.

This gives you the amount of tax you paid as a percent of your total income or your effective tax rate.

Here’s a quick example. John Smith made $38,800 of taxable income and filed single. His federal income tax ended up being $4,475.50 because he had no other taxes to pay or tax credits to claim.

To figure out his total income, John would add back the standard deduction of $12,000 for single people.

He didn’t have any pre-tax benefits or have any other tax deductions, so his total income was $50,800.

He divides his tax of $4,475.50 by his total income of $50,800 to get an effective tax rate of 8.81%.

This is significantly less than his marginal income tax bracket of 12% due to his standard deduction and the way the marginal tax bracket system works.

Most states have marginal income tax brackets, too

Everything we’ve discussed above to this point has dealt with the federal income tax brackets. However, many states have marginal income tax systems, too.

The Tax Foundation has a great resource detailing how each state taxes income. You can look up your individual state’s requirements, but here are the highlights:

  • Of the 50 United States, seven of them don’t impose an income tax at all.
  • Another eight states only impose one tax rate on all income.
  • Another two states only tax dividend and interest income.

That means 17 states do not have marginal income tax structures for wage income.

That said, the other 33 states do have many tax brackets and marginal income tax structures.

Each state may offer different state tax deductions and state tax credits, but the rest do have marginal income tax brackets that have increasing rates with increasing income.

Final Thoughts

Understanding how your federal and state income taxes are calculated is important.

Knowing that federal income taxes work on a marginal income tax structure can help you make smarter decisions.

For instance, you can work overtime knowing only your additional income will be taxed at a higher rate, not all of your income.

Hopefully, you can help educate others how federal taxes really work, too.

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