Marginal Tax vs Effective Tax

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How much do I really pay?

A common misconception regarding taxes is the total amount owed based on the highest marginal tax bracket. For example, some people believe that if their income reaches the 37% marginal tax bracket, they will owe 37% of their entire income to the IRS. This is false and can lead to poor retirement planning.

Marginal Tax Rate

The Marginal tax rate is the amount of tax applied to each level of income. The Effective tax rate is the actual percentage that you pay. Our federal government utilizes a progressive tax system, which means the higher your income, the higher your marginal tax rate. 2019 marginal taxes are divided into seven brackets: 10%, 12%, 22%, 24%, 32%, 35% & 37%

For this example, we’ll use a “married couple filing jointly” with an annual income of $150,000 after deductions. This puts their top marginal tax bracket at 22%.
 

Marginal Income Level Taxable Tax owed
10% $0 – $19,400 $19,400 $1,940
12% $19,400 – $78,950 $59,550 $7,146
22% 78,950 – $150,000 $71,050 $15,631
Total tax liability $24,417
Effective tax 16.27%

 
Effective Tax Rate

The effective tax rate is the actual percentage of your annual income that you owe to the IRS. To calculate your effective tax rate, you must divide your total tax liability by your annual income. 24,417 / 150,000 = 16.27%. So, whereas the marginal tax bracket is 22%, this couple’s effective tax is 16.27%
 
Keep in mind this example does not factor State, local or FICA tax into the equation.
 

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