We can’t go through tax season without covering how federal income tax brackets work. The U.S. has a progressive tax system. While someone may be sitting in the 25% federal tax bracket, that doesn’t mean they actually pay that much in taxes. It only means that 25% is the marginal tax rate.
The marginal tax rate represents the tax rate on the last dollar of your income earned. It doesn’t represent the tax rate on your total taxable income.
To find the tax rate we pay on our total taxable income we need to find the average tax rate. Which takes a bit of math.
The best way to explain it is with an example. I’ll be using the 2012 federal tax brackets for a single person as a reference. For our example we’ll assume this single person has a taxable income of $500,000. Which is beyond average but I wouldn’t be able to use the entire table below that I labored over for hours. Continue Reading…