Marginal tax rates and actual tax rates - what you need to know is...
Marginal tax rate
The marginal tax rate is the amount of tax paid on an additional dollar of income. Add one dollar of taxable income to your tax return, determine the amount of additional tax you want to pay, and then divide the income tax by the amount of $1. The result is your marginal tax rate.
Confused? Let us review it. The federal income tax system in the United States is gradual. Therefore, not all taxable income is taxed at the same rate. It's like climbing stairs. The tax level is the step. The more you do, the more steps you have to take. You can see all the status of the 2014 federal tax declaration here.
When most people talk about marginal tax rates, they refer to the highest tax rate for taxable income. For example, a person with an annual taxable income of $1,000,000 has a marginal tax rate of 39.6%. Personal income tax is $425,000. why? The top bracket applies to taxable income of more than $406,750 for a single taxpayer. Individual taxable income of $100,000 is within the scope of 28%.
This is the key. The marginal tax rate does not mean that all of the $100,000 taxable income is taxed at a rate of 28%. In this example, the 28% marginal tax rate is your last $11,000 income -- $93,350 to $100,000. Suppose the taxpayer still has to pay 10% of the first $90,705 taxable income, just like other taxpayers. She still pays 15% of her income between $90,075 and $39,600, and so on.
Your marginal tax rate is only the tax rate you pay on the last dollar of taxable income.
Exceeding tax range
So far, we are completely focused on taxes. However, the marginal tax rate can be a bit complicated. Especially for high-income earners, as incomes increase, various deductions and credits are phased out. In other words, when you make more money, the value of some deductions and credits will decrease.
The purpose of phasing out is to focus tax incentives on those with lower incomes. Phase-out is important in calculating the marginal tax rate. For example, if an additional dollar of taxable income is reduced by deductions or credits, then DISH should be considered when determining the marginal tax rate.
These phasing out are important. For example, when assessing the benefits of pre-tax retirement contributions, your marginal tax rate should take into account these phasing out. Their role is to increase tax incentives for retirement contributions, which is an important consideration when assessing whether to contribute to a pre-tax retirement account or a Roth retirement account.
Actual tax rate
Effective tax rates are easier to understand and calculate. It is simply the total income tax paid by the individual divided by the total income. The actual tax rate is usually much lower than the individual's marginal tax rate.
Effective tax rate calculations have several purposes. First, it is helpful to compare your total tax revenue from one year to the next. Second, it helps to compare the overall tax liability between different individuals. This is very important when formulating an income tax policy.
Mixed tax rate
In general, marginal tax rates are used for financial decisions. For example, when assessing the benefits of a charitable donation, people will consider his or her marginal interest rate. Similarly, when assessing whether to contribute to a pre-tax retirement account or a Roth retirement account, people usually consider marginal interest rates. However, when making these decisions, you must consider not only the marginal tax rate.
The shift from a marginal tax rate to another marginal tax rate, as well as the phasing out of deductions and credit, complicates the choice between pre-tax and Ross retirement accounts. On the plus side, it offers some potential for real tax savings. We will examine these potential tax savings in the next article in this series.