UNDERSTANDING YOUR MARGINAL TAX RATE

Ever wonder what the term “tax bracket” means? It refers to the top marginal tax rate that individuals are being taxed, not the average. Knowing your marginal rate is important, because any increase or decrease in your taxable income will affect your tax at your top marginal rate. Thus, if you are in the 25% marginal bracket and plan on signing up for your employer’s 401(k) plan, you will generally save $250 ($1,000 x .25) in federal taxes for each $1,000 contributed to the 401(k) plan. The reason we say “generally” is because sometimes a tax deduction can actually drop you into a lower marginal tax bracket.

The table below reflects the marginal tax bracket for various taxable incomes. Keep in mind that not all of your income is taxed. The amount equal to the sum of your deductions and exemptions is not taxed at all. If your income is below the sum of your deductions and exemptions, you would not have a taxable income, and your marginal rate would be zero.

However, once your income exceeds the sum of your deductions and exemptions, you will have taxable income and your marginal tax rate can be determined from the table. For example, let’s assume that your income for the year is $50,000. You are married with two dependent children and will take the standard deduction. The standard deduction in 2016 for a married couple is $12,600 ($12,700 in 2017). The exemptions for 2016 and 2017 are $4,050. Thus, your taxable income for 2016 would be $21,200 ($50,000 – $12,600 –$4,050 x 4)). For a taxable income $21,200, the marginal tax rate from the table (table values illustrated are the top of each bracket) is 15%.