You can’t go through tax season or file your taxes without knowing how tax brackets work. The U.S. has a progressive tax system that does one thing well, it tells you the tax bracket you fall into, but it doesn’t tell you the whole story.
While someone may sit in the 25% federal tax bracket, that doesn’t mean they actually pay that much in taxes. In fact, they pay less than 25% in taxes because of how the tax system works. Let me explain.
Marginal Vs. Effective
The tax bracket you fall into is your marginal tax rate. The marginal tax rate represents the tax you pay on the last dollar you earn. But it’s not the tax rate you pay on every dollar you earn.
To find the tax rate you pay on your total taxable income, you need to find the average tax rate, called your effective tax rate. To do that, you need a bit of math.
How It Works
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 this example, assume this single person, let’s call her Sue, has a taxable income of $500,000. Sue’s income is far above average (because I wouldn’t be able to use the entire table below that I labored over for hours). Continue Reading…
The biggest reason anyone fails at their finances is because they never really start. Sure, they may get through a few weeks. But then it falls off. We lead busy lives and sometimes we let things slide. So it becomes tomorrow’s problem.
There are only two ways of improving your financial situation and neither involves an insurance scam, lottery, gambling, selling a kidney, or a myriad of other legal or illegal activities. In fact both are covered abundantly on finance blogs and websites. Yet the topic is skirted around rather than just getting to the point.
The Facebook IPO news is rolling strong this year as one of the biggest IPOs since Google went public years ago. It’s not surprising really, with 800 million people using the social site and the billions of dollars the IPO will generate for early investors and employees. Just think of all the new millionaires and billionaires that will be added to Forbes richest people list once the company is public. Which is the real reason behind the Facebook IPO this year and a great lesson in tax planning.