What is Taxable Income, Tax Brackets, and Marginal Tax Rates?

Marginal tax rate and your effective tax rate are not the same thing. Moving into a higher marginal tax bracket does not mean your entire income is taxed at that rate. Different amounts of income will be taxed in different tax brackets. The marginal tax brackets for 2013 are listed here (2014). A combination of all the tax rates will be considered your effective tax rate and is a straight percentage of your income that is being taxed.

What is Taxable Income, Tax Brackets, and Marginal Tax Rates?

For example, if you’re a single filer that has $34,000 in taxable income. What would happen to your taxable income if you get a raise? At $34k you’re just under the cutoff for the 25% tax bracket, and now your marginal tax rate is 25% after the raise. Are you really “making” more money, but losing virtually all of it to the increased tax burden?

 

Using Tax Brackets 2014

No. Since the tax brackets are delineated by the marginal tax rate (the tax rate at which the next dollar you earn is taxed), only the amount above the 25% bracket threshold ($36,901) is taxed at 25%. Your tax calculation looks like this:

  • $8,925 at 10% = $892.50 ($8,925 in taxable income)
  • $27,325 at 15% = $4098.75 ($36,250 – $8,925 in taxable income)
  • $3,750 at 25% = $937.50 ($40,000 – $36,250 in taxable income)
  • Total tax = $5,928.75, effective federal rate = 14.8%

The marginal tax rates only apply to taxable income – that is, your income after all of your deductions and exemptions are factored into your total income. Your total income is listed in line 22 of the 1040 form, while your taxable income is listed in line 43 of the 1040.

 

Tax Deductions and Brackets in 2014

Everyone is entitled to deduct certain things from their taxes. Deductions reduce the amount of income that is subject to tax – they reduce your taxable income. Deductions fall into three major categories: the standard deduction, itemized deductions, and “above the line” deductions.

  • The standard deduction in 2013 is $6,100 for single filers in tax year 2013 ($6,200 for 2014). If you claim the standard deduction, this is what you’d put in line 40 of Form 1040.
  • If you want to claim itemized deductions, of which a number of expenses qualify, you need to include Schedule A with your tax filing. The total of your itemized deductions goes in line 40 of the 1040 form. The major itemized deductions are for home mortgage interest, state/local/property taxes, and charitable donations.
  • “Above the line” deductions are listed in lines 23-35 of the 1040. Most require additional documentation to show eligibility.

 

Should I itemize my deductions or just take the standard deduction?

One of the most common tax questions we get here is “Should I itemize my deductions or just take the standard deduction?” If the sum of your itemized deductions is not larger than the standard deduction, you’re almost always better off claiming the standard deduction.