How Federal (IRS) Income/Salary Tax Brackets Really Work

Just because your income puts you in the X or Y % tax bracket, that doesn’t mean that is really what percentage of your income you pay in taxes. We actually have a progressive tax system in place in the US, where you are taxed at different levels as your income increases. I wrote about the 2010 tax rates before on the site, and will discuss them a little later, but people often have the misconception that if their income falls in the 25% tax bracket it means that they pay a full 25% in taxes. This is simply not the case, and I wanted to put together a little post to explain how the tax brackets actually work. Throughout this post, I will use the figures from the “Filing as a single” tax brackets, as that is how I file:

10% Tax Bracket – $0-$8,375
15% Tax Bracket – $8,375-$34,000
25% Tax Bracket – $34,000-$82,400
28% Tax Bracket – $82,400-$171,850
33% Tax Bracket – $171,850-$373,650
35% Tax Bracket – $373,650+

These are the single tax brackets for when you file your 2010 tax returns next April. To show you how these brackets work, let’s create a very simple tax-paying citizen who is single and makes $50,000 per year. That $50,000 is this person’s total income, but not the amount they are taxed on. The amount this person would be taxed on would be their AGI, or Adjusted Gross Income, which is the amount left after they take their standard deduction of $5,700 for the 2010 tax year. Taking this deduction makes their taxable income $44,300 for the year. This is the number we will work off of.

Using the brackets I listed above for a single person, this person is taxed at 10% for the first $8,375 of their income, at 15% for everything between $8,375 and $34,000, and so on, up to the total amount of their income. Let’s break it down to see the taxes due amount for each bracket:

10% Tax Bracket – $8,375 x 0.10% = $837.50 in taxes
15% Tax Bracket – Everything between $8,375 and $34,000, which totals $25,625 x 0.15% = $3,843.75 in taxes
25% Tax Bracket – Everything between $34,000 and $44,300 (the AGI for this filer), which totals $10,300 x 0.25% = $2,575 in taxes

So, this person, with an AGI of $44,300, owes $837.50 + $3,843.75 + $2,575 in taxes, which equals $7,256.25 for the year. As I mentioned above, if they had thought they had to pay 25% on their total income (a common assumption people have), they would have had to pay $11,075… and not the much smaller amount of $7,256.25. Instead of seeing our income fall into a certain tax bracket on appearance alone, our progressive tax system instead gives us an “Effective Tax Rate”, which is figured out by dividing your total tax due by your taxable income. For this filer, this rate is $7,256.25 / $44,300, equaling 16%. This is how much this person is being taxed, which is a far cry from their initial thought of being taxed at 25%.

When people complain about being taxed at X %, they are often just using the numbers from the tax brackets and not doing the math to compute the actual rate they pay. And in this case, a 16% tax rate is MUCH different than a 25% tax rate, so it’s important to note how our taxes are figured out rather than just going by the brackets themselves. And now you know!

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Comments (5)

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  1. Dee says:

    Thanks for the post!

    Question, though: Wouldn’t the effective tax rate be calculated as a percentage of the total income ($50k), and not of the AGI?
    Thus, the effective tax rate on $50k is about 14.5 percent.

  2. I had no idea that waS how our tax system really worked…


  3. […] How Federal (IRS) Income/Salary Tax Brackets Really Work @ My Two Dollars […]

  4. Federal Tax says:

    I like your post about How Federal (IRS) Income or Salary Tax Brackets Really Work. File your federal tax filing electronically and get fast tax refund. E filing is one of the best options. Now easy to file your federal taxes and get rapid tax refund in your account.

  5. Wendy says:

    You have the general idea David, but I’m afraid that your math is not quite correct. You appear to have forgotten the Personal Exemption of $3650. So the correct estimate for an individual filer earning $50k per year would be:

    Estimated Federal Tax Summary
    AGI 50,000
    *Deductions – 5,700
    *Exemptions – 3,650
    Taxable Income = 40,650
    Bracket: 25.0%
    Estimated Tax: 6,344

    $6,344 = $837.50 + $3,843.75 + $1,662.5

    $1,662.5 = .25(40,650-34,000)

    The above estimate is before consideration of any capital gains or dividends, which would be taxed differently. It also assumes a simple case where the filer’s Gross Pay is $50k and he has not made any allowable pretax contributions, such as 401k, health plan, and FSA contributions. Or we could say that the example assumes that our filer’s W-2 wages are $50k net– that is, after accounting for allowable pretax contributions.

    Hope this helps,