How Do Tax Brackets Work?
When I was younger and I just started working, I didn’t know how tax brackets worked because I would do my return in TurboTax and pay whatever I owed. I didn’t care much about tax brackets because, honestly, it didn’t really matter to me. So one day I look at the Federal tax brackets and was perplexed as to how they were set up (this was back in 2003 but in order not to confuse you, I’ll use 2013 tax bracket numbers in my story). I was making a great salary for a 23 year old, around $60,000, a year and I saw that I was firmly in the 25% tax bracket. When I went to do my taxes, I saw that my effective tax rate, as reported by Turbotax, was actually
Why were my taxes so low? First, I started working in June so my wages were less than $40,000 (I had a small signing bonus and I also worked my last semester of college), and after the standard deduction and 401(k) contributions, my taxable income was around $25,000. That next year, I was given a raise of 4% and I saw that I’d still be in the 25% bracket but my effective tax rate was under 14%.
Marginal Tax Rates
The reason is because the brackets don’t illustrate your tax rate on all of your income, just the income that falls within the bracket itself. That’s what marginal means, the tax rate is assessed on your next dollar, not every dollar. Here are the 2013 tax brackets:Source: www.bargaineering.com