Under the federal income tax system, different portions of your income are taxed at different rates. As your income goes up, so does the highest tax rate you must pay. Your "tax bracket" is simply the highest tax rate that applies to any portion of your income. But unless you are in the lowest bracket, the actual amount you pay in income taxes will be less than your "bracket rate."
Your tax bracket depends not on your gross income, which is the total amount of money you made during the year. Instead, it's based on your taxable income, which is what's left over after you've subtracted all of the deductions and exemptions to which you're entitled. The bulk of the standard federal income tax return guides you through the process of adding up your gross income and whittling it down to your taxable income.
Congress sets the rules for how many federal income tax rates there are, and the income levels at which those rates kick in usually change each year to take inflation into account. For the 2011 tax year, for example, there were six possible rates -- and therefore six possible tax brackets: 10 percent, 15 percent, 25 percent, 28 percent, 33 percent and 35 percent. For a single taxpayer, for example, the 10 percent rate applied to taxable income from zero to $8,500. The 15 percent rate applied to taxable income from $8,500 to $34,500. The 25 percent rate applied from $34,500 to $83,600. The 28 percent rate applied from $83,600 to $174,400. The 33 percent rate applied from $174,400 to $379,150, and the 35 percent rate applied to taxable income above $379,150.
How It Works
Let's say you were a single taxpayer with a taxable income of $90,000 in 2011. That puts you in the 28 percent tax bracket, but you don't pay 28 percent of your total taxable income. Instead, the first $8,500 is taxed at 10 percent, for a tax of $850. The portion from $8,500 to $34,500 -- that is, $26,000 -- is taxed at 15 percent, or $3,900. The part from $34,500 to $83,600 -- or $49,100 -- is taxed at 25 percent, or $12,275. The last $6,400 worth of income -- everything from $83,600 to $90,000 -- is taxed at 28 percent, or $1,792. Add it up and your tax bill is $18,817. Although you're in the 28 percent bracket, your actual bill comes out to about 20.9 percent of your taxable income.
A common misconception is that getting a raise that puts you into a higher tax bracket will leave you with less take-home income. This fallacy is based on the incorrect assumption that your bracket rate applies to your entire income. The higher tax rate will apply only to the part of the raise that crosses into the next bracket. However, a raise could hurt you if it pushes your income to a high enough level that you're no longer eligible for certain deductions or tax credits.
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