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Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Marginal Tax Rate

What it is:

The marginal tax rate is the percentage of tax applied to your income for each tax bracket in which you qualify. In essence, the marginal tax rate is the percentage taken from your next dollar of taxable income above a pre-defined income threshold.

The marginal tax rate includes federal, state and local income taxes, as well as federal payroll and self-employment taxes. This differs from the average tax rate, which is the total tax paid as a percentage of total income earned.

How it works (Example):

Federal income tax in America is considered a progressive tax. There are income tax brackets to assure this with increasing marginal tax rates for each bracket.

As you can see, those who make the least amount of money owe the lowest marginal tax rate. The more money one makes, the higher the marginal tax rate for each bracket in which your income is taxed.

This table can be a little confusing without further explanation. Please note that everyone is taxed in steps. A person earning $100,000 is not taxed 28% on the entire amount. Instead, he is taxed 10% on the first $8,350 earned, 15% for the portion $8,351to $33,950, 25% for $33,951 to $82,250, and 28% for the remainder:

This clarification is important to quell some misleading rumors. It has been suggested that if an employee earning $33,950 (take home after taxes: $28,857) is offered a $5 pay raise (enough to boost him into the next tax bracket), it will actually decrease the total amount he takes home (suggested take home after taxes: $25,466). But this is incorrect. Only the $5 above $33,950 will be taxed the higher 25%. In this case, his ACTUAL after taxes take home would be $28,861.

[InvestingAnswers Feature: The Most Important Tax Changes to Know Before Filing Your Tax Return]

Why it Matters:

Your marginal tax rate has important implications for financial planning. You need to know your marginal tax rate to calculate what amount of your raise or bonus you’ll get to keep after taxes or whether it is worthwhile to contribute more to your tax-advantaged retirement account.

[InvestingAnswers Feature: How to Avoid an IRS Audit]

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