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What's with all these different tax rates? - 2/10/2022

Updated: Jul 29, 2022

You have probably heard many different terms when people talk about tax rates - graduated, progressive, average, effective, and marginal.

Graduated and progressive tax rates are the same thing. The tax rate goes up as you reach different levels of taxable income. So your first dollar of taxable income is at a lower rate than your last dollar of taxable income, like a set of stairs where each step is a higher rate. Not all dollars will be taxed the same.

Average and effective tax rate are the same, these are the overall percentage of your income that you pay in taxes. These cannot be easily computed ahead of time since even if you know your total income it is not always easy to project any adjustments for non-taxable income. Depending on what you are trying to compare, you may use your total income or your total taxable income to determine your average taxes, but be consistent so that you have a useful average tax rate. Typically when average tax rate is being discussed it is based on total taxable income.

The marginal rate is the tax rate on the last dollar earned. In progressive taxation, as I listed above, as you reach higher levels of income the additional dollars are taxed at higher rates. Marginal tax rate is what you are paying on the highest dollar.

The below example assumes that all income is W-2 income so the taxes are straight from the IRS tax tables. The tax tables go up to $99,000 in income, anything above that must do actual computations from the bracket listings. Tax tables are there to make things easier for taxpayers, and are broken into $50 income ranges so there is not a significant difference whether computed by the table or the computation schedules.

For example, if I take a single taxpayer who has taxable income of $10,000, their tax is $1,004 from the tax table or $1,001 as computed below

the first $9,950 is at 10%

the next $50 (the difference between $10,000 and $9,950) is at 12%

The average tax rate is 10.04%

If a single taxpayer has taxable income of $50,000, their tax is $6,754 from the tax table or $6,748 if I calculate it manually from the rates

the first $9,950 is at 10%

the next $30,574 (the difference between $40,525 and $9,950) is at 12%

and the final $9,474 ( the difference between $50,000 and $40,525) is at 22%

the average tax rate is 13.51%, but the marginal tax rate is 22%

*Be aware that there are many items that can impact how your taxes are computed since there is favorable treatment for some types of capital gains, qualified dividends, and other income items. The more complex your tax return is, the more likely you need to consult a professional tax preparer to make sure you pay the least amount of tax.

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Feb 10, 2022

This was very helpful. Thank you.

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