How Do Tax Brackets Work?

7 minute read

What Is a Tax Bracket?

A tax bracket is a range of income levels that are taxed at a specific rate. The US federal income tax system currently has seven tax brackets, with rates ranging from 10% to 37%. As your income increases, you move into higher tax brackets and pay a higher tax rate on each additional dollar of income. This is known as a progressive tax system, as the tax rate increases as the income level increases.

It's important to note that the tax brackets only apply to the portion of your income within each bracket. For example, if you're in the 22% tax bracket, you won't pay 22% on all of your income; you'll only pay 22% on the portion of your income that falls within that bracket. The rest of your income will be taxed at lower rates.

History of Federal Tax Brackets

The federal tax bracket system has been in place since the introduction of the income tax in 1913. However, the number of tax brackets and the specific income levels and tax rates have changed significantly over the years. In the early years of the income tax, there were only a few tax brackets with relatively low tax rates. In the 1930s and 1940s, the number of tax brackets increased and the tax rates rose to fund the country's involvement in World War II.

In the decades that followed, the tax brackets and rates fluctuated, with the number of brackets increasing during some periods and decreasing during others. The Tax Reform Act of 1986 simplified the tax bracket system and reduced the number of brackets from 15 to two, but the number of brackets has since increased again. Today, the federal income tax system has seven tax brackets.

It's worth noting that the tax bracket system is not set in stone and can be changed by Congress at any time. The tax brackets are often adjusted annually to account for inflation and changes in the economy. This helps to ensure that the tax system remains fair and that people are not taxed at higher rates simply because their income has increased due to inflation.

Tax Rates vs. Tax Brackets

It's important to understand the difference between tax rates and tax brackets because they work together to determine the total amount of taxes you owe. Your tax bracket determines the tax rate that applies to each portion of your taxable income, while your tax rate determines the percentage of your income that you owe in taxes.

For example, the 2022 federal income tax system has seven tax brackets, with tax rates ranging from 10% to 37%. This means that if you're a single filer, the first $11,000 of your taxable income will be taxed at a rate of 10%, and your income from $11,001 to $44,725 will be taxed at a rate of 12%. The rest of your taxable income will be taxed at higher rates, depending on the tax bracket it falls within.

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What is Bracket Creep?

Bracket creep is a phenomenon that occurs when inflation causes a taxpayer's income to rise into a higher tax bracket, even though the increase in income may not have been substantial in real terms. As a result, the taxpayer is taxed at a higher rate on their income even though their purchasing power has not increased proportionally.

Tax brackets in 2022

For the 2022 tax year, the federal income tax system has seven tax brackets, with tax rates ranging from 10% to 37%. The specific income levels and tax rates for each tax bracket vary depending on your filing status, which can be single, married filing jointly, married filing separately, or head of household.

Here is a summary of the 2022 tax brackets and tax rates for single filers:

  • 10%: $0 to $9,950
  • 12%: $9,951 to $40,525
  • 22%: $40,526 to $86,375
  • 24%: $86,376 to $164,925
  • 32%: $164,926 to $209,425
  • 35%: $209,426 to $523,600
  • 37%: over $523,600

Calculating your marginal tax bracket vs. your effective tax rate

Have you ever wondered why the amount of taxes you owe doesn't always seem to match the tax bracket you're in? The reason is because there's a difference between your marginal tax bracket and your effective tax rate.

Your marginal tax bracket refers to the highest tax rate that you pay on your taxable income, while your effective tax rate is the average rate at which your taxable income is taxed, taking into account all of the different tax rates that apply to different portions of your income.

Let's take a look at an example. If you're a single filer and your taxable income is $100,000 in 2022, your marginal tax bracket would be 35% because that is the highest tax rate that you would pay on any additional dollars of income. However, to calculate your effective tax rate, you would divide the total amount of taxes you owe by your taxable income. If you owe $30,000 in taxes, your effective tax rate would be 30% (30,000 ÷ 100,000).

It's important to understand the difference between your marginal tax bracket and your effective tax rate because they give you a more complete picture of your tax liability. Your marginal tax bracket is useful for understanding the tax rate that would apply to any additional dollars of income, while your effective tax rate is useful for understanding the overall average rate at which your taxable income is taxed.

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