Tax Brackets 101

Apr 8 2011 @ 8:16am

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A reader writes:

Please, please, please can you help raise awareness of this very important feature of our tax code: We all are subjected to the same tax rates for the first increments of taxable income. We have to pay higher tax rates only on the increment. Bill Gates pays the same taxes on the first $10K that he makes as does the Safeway clerk on the first $10K that she makes. As explained clearly in the Wikipedia entry:

An individual's marginal income tax bracket depends upon his or her income and tax-filing classification. As of 2008, there are six tax brackets for ordinary income (ranging from 10% to 35%) and four classifications: single, married filing jointly (or qualified widow or widower), married filing separately, and head of household.

An individual pays tax at a given bracket only for each dollar within that bracket's range. For example, a single taxpayer who earned $10,000 in 2009 would be taxed 10% of each dollar earned from the 1st dollar to the 8,350th dollar (10% × $8,350 = $835.00), then 15% of each dollar earned from the 8,351st dollar to the 10,000th dollar (15% × $1,650 = $247.50), for a total of $1,082.50. Notice this amount ($1,082.50) is lower than if the individual had been taxed at 15% on the full $10,000 (for a tax of $1,500). This is because the individual's marginal rate (the percentage tax on the last dollar earned, here 15%) has no effect on the income taxed at a lower bracket (here the first $8,350 of income taxed at 10%). This ensures that every rise in a person's pre-tax salary results in an increase of his after-tax salary.

I have found that a surprisingly small percentage of Americans know this. And they don't even believe me when I tell them. Not surprisingly, I have also found that most people with income topping out in the lower rate brackets would gladly pay a higher percentage of taxes if they were to make another $100K, and would pay more yet on the next $1M.