When talking about taxes, the issue of tax bracket often comes up and it’s an important factor in deciding what tax options are best for your situation. The problem is that the average person probably doesn’t know which tax bracket they are in. Knowing your tax bracket can be useful when trying to make decisions that affect your taxable income each year. For example, if you work a second job, sell some stock, or do a ROTH IRA conversion, how much will you be taxed on these different scenarios? You will have no clue unless you have know what tax bracket your fall under.
The easiest way to figure out your tax rate is to grab last year’s tax return. Assuming you filed the standard Form 1040, look at line 43 of the form. The number you see on that line is your taxable income. Of course the big assumption here is that your tax situation is quite similar this year as to last year. However, if you expect a difference, you can add more income to the number, or subtract new deductions you expect, to arrive at an estimate of your taxable income for 2007.
Now that you have an idea about your taxable income, next you just need to look at the tax tables to see what rate you are at. Federal income taxes are graduated, meaning, you pay 10% tax on the first x amount you earn, and 15% on the next y amount you earn, etc. If your tax bracket is 25% it means the highest tax rate you are hit by is the 25% tax rate, but your entire income is not taxed at that rate.
So, let’s look at the tax tables. Assume you are single – then you would look at the first table – labeled “single”. If your taxable income was $77,100, you will see you are in the 25% tax bracket. However, if you made any more money, it would be subject to the 28% tax rate. This is because you are at the very upper end of the 25% tax bracket. Likewise, if your taxable income was $50,000, you would be well into the 25% tax bracket, but could easily make another $27,000 in taxable income before becoming subject to the higher 28% tax rate.
The highest tax bracket you are in is usually called your “marginal tax rate.” If your tax return is prepared professionally, or if you did it with tax software, often you will get a summary sheet that will show your marginal tax rate. This may be an easier way to figure out where you stand, though not as informative as you won’t know if you perhaps may be at the lower end or the higher end of the tax bracket.
There is just one other caveat to this. If you are single and rent without a lot of investments, your payroll will mirror more closely your taxable income than say someone with a large mortgage and four kids. For someone with a large mortgage and kids, they will get some significant write-offs and their taxable income can be vastly different from their paycheck. As with anything when it comes to taxes, it can quickly becomes very complicated. But hopefully this can shed a little more light on your own tax situation.