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Understanding Marginal VS Effective Tax Rate

The United States has a progressive tax system. What this means is the more money you earn, the more income tax you will pay. There are currently seven tax brackets ranging from 10% to 37%.

If you are single and earn $35,000 per year, your tax rate is 12%. If you are single and earn $520,000 you are in the top bracket which is 37%. These rates are Marginal Rates, and this is what most people are referring to when they say what their income tax rate is. However, this is where the confusion begins.

Marginal rates apply to each additional level of income earned. Meaning the first level of income is taxed at the lowest rate and this increase as your income increases. This illustration shows how a single taxpayer earning $100,000 works.

Tax Bracket Amount Tax
10% Bracket on the first $9,950 $995.50
12% Bracket on (40,525 – $9,950) $30,750 $3,669
22% Bracket on (86,375 – 40,525) $45,850 $10,087
24% Bracket on (100,000 – $86,375) $13,625 $3,270
Total Tax $18,021.50

In this case, the Marginal rate was 24% But the Effective rate was 18%!

This example did not include Capital Gains Tax – an only tax on earned income.
Capital Gains are taxed differently

Short Term (less than one year) is treated as normal income.

Long Term (longer than one year) taxed at 0%, 15% and 20%.

Although most people talk about their Marginal Rate it is the Effective Rate that really affects your pocketbook.