So how does the government decide how much taxes we should pay? The amount of taxes we pay is dependent on the amount of income we make. “The United States uses a progressive tax system. That means the higher your income, the bigger the share of it you’ll pay in taxes. The rationale behind this is that the more money you have, the greater your ability to pay taxes compared with a less-well-off person.”1 Your income places you in a certain tax bracket. For any income within that tax bracket you will be taxed a certain percentage. This percentage is called your “Marginal tax rate”.
This post is focused on Federal Income taxes brackets but here are some nuggets on Federal Insurance Contributions Act (FICA) taxes (Social security & medicare) and state taxes. Social Security is taxed at a flat 6.2% on gross wages up to $137,700 (this is a gross wage increase of $4,800 from 2019). The maximum social security you will pay based on this $8,537.40. Medicare tax rate is 1.45% with no limit on gross income. Note income exceeding $200,000 are subject to a 0.9% medicare tax withholding. In regards to your state marginal rates they will differ from federal, be flat, or they may be no state taxes.
Now back to Federal tax brackets. Below is a chart of 2020 Federal Tax Brackets and Marginal Tax rates.
2020 Tax Brackets
| Marginal Tax rate | Single | Married, filing jointly | Married, filing separately | Head of household |
| 10% | $0 to $9,875 | $0 to $19,750 | $0 to $9,875 | $0 to $14,100 |
| 12% | $9,876 to $40,125 | $19,751 to $80,250 | $9,876 to $40,125 | $14,101 to $53,700 |
| 22% | $40,126 to $85,525 | $80,251 to $171,050 | $40,126 to $85,525 | $53,701 to $85,500 |
| 24% | $85,526 to $163,300 | $171,051 to $326,600 | $85,526 to $163,300 | $85,501 to $163,300 |
| 32% | $163,301 to $207,350 | $326,601 to $414,700 | $163,301 to $207,350 | $163,301 to $207,350 |
| 35% | $207,351 to $518,400 | $414,701 to $622,050 | $207,351 to $311,025 | $207,351 to $518,400 |
| 37% | $518,401 or more | $622,051 or more | $311,026 or more | $518,401 or more |
Please understand that this does not mean that all your income is charged at that tax rate. As stated above the tax system is progressive so you pay the tax rate for the incremental income within that range. You are paying a higher rate on your highest dollars.
Here is an Example. You are a single filer and with taxable income of $50,000.
Based on the chart above you would pay a 10% tax rate on income up to $9,875. Everything between 9,876 to 40,125 would be taxed at a rate of 12% (12% on 30,249). Then income between 40,126 to 50,000 would be taxed at a rate of 22%.
Below is the example in chart format:
Note: This example does not take into consideration deductions, retirement accounts, HSA, or FSA’s which lower your taxable income. This will be covered in our next post.
| Taxable Income: | 50,000 | ||
| Marginal Tax rate | Single | Income within Bracket | Taxes (Income within bracket * Marginal tax rate) |
| 10% | $0 to $9,875 | $9,875 | $988 |
| 12% | $9,876 to $40,125 | $30,250.00 | $3,630 |
| 22% | $40,126 to $85,525 | $9,875.00 | $2,173 |
| Total: | $50,000 | $6,790 | |
| Effective Tax Rate: | 13.58% | ||
| (Excludes FICA, state, & local taxes) |
In this example you would pay $6,790 in taxes. Your effective tax rate which is the actual percentage of taxes you pay on taxable income (Total Tax / Taxable income) would be 13.5% in this example. If we went further and considered your FICA, state, and local taxes we would get your total effective tax rate. Understanding your marginal tax rate and effective tax rate is a great way to start thinking about your tax strategy. So take the time to know your numbers. Then you can get to the fun part of strategies to lower your taxable income. Stay tuned for our next post on this: How to lower your table income.
NOTE: If you want to play around with salary numbers click here for a fun Federal Income Tax calculator that I created
(https://www.creditkarma.com/tax/i/tax-definition-why-we-pay-them/)1
