Tax brackets are ranges at which different portions of your income are taxed. The U.S. tax system is set up in a way where each individual pays the same tax on the same income level. The current tax system is a progressive one meaning that the more you earn the more you owe in taxes.
Before I explain this with couple of examples, here is a look at how the current tax brackets look like:
The brackets are the cut off amounts and they are different based on how you file your tax returns: single, married filing jointly, married filing separately, or head of household.
As an example let’s compare two individuals, Person A made $45,000 last year and Person B made $90,000. Both file as Single and each pays 10% on the first $8,925 of their income. The portion between $8,925 and $36,250 is taxed at 15%. Now for the next bracket, Person A pays taxes only up to what he/she earned, that is $45,000 while Person B continues until he/she reaches its income level. So here how the numbers break down:
The effective tax rate for both individuals is different due to differences in income level. It is also different from every bracket rate established. The same methodology can be applied for all income levels and filing status. In this hypothetical example, Person B’s effective tax rate is 20.55% vs. 15.95% of Person A. This is because Person B has a greater portion of his/her income taxes at higher tax brackets.
Tax brackets change periodically so make sure that are aware of the most recent ones. If you have your taxes made your tax preparer should be aware of those changes; similarly tax preparation software is always up to date with any tweaks to tax brackets.
Amending or filing past taxes
If you decide to amend previous year taxes or file for the first time make sure that you use the appropriate tax brackets. Do not use current tax brackets for income earned in 2012, 2011 or 2010. For information on past tax brackets and rates, click here.