ArticlesFinance & EconomicsHow Do Tax Brackets Work?

11 months ago6 min

The concept of marginal income tax brackets is often misunderstood.  We may hear someone say, I don’t want to make another dollar of income because it will push me into the next tax bracket, but what is the actual consequence of making that additional dollar of income?

As of 2018, there were 7 income tax brackets for individuals and families (not companies or certain types of trusts) that ranged from rates of 0% all the way up to 37%.

Rate For Unmarried Individuals, Taxable Income Over For Married Individuals Filing Joint Returns, Taxable Income Over For Heads of Households, Taxable Income Over
10% $0 $0 $0
12% $9,525 $19,050 $13,600
22% $38,700 $77,400 $51,800
24% $82,500 $165,000 $82,500
32% $157,500 $315,000 $157,500
35% $200,000 $400,000 $200,000
37% $500,000 $600,000 $500,000

Each bracket represents the rate applied to the income you earned for the year that fell within that range.  To use the simplest real-world example based on the 2018 brackets, if you were an unmarried individual who earned $9,526 of federally taxable income during the year, you would owe 10% of the first $9,525.00 ($952.50) and 12% of the next $1.00 ($0.12) for a total federal tax due of $952.62.  You would not owe 12% on the full $9,526.00.  This is where some people become confused thinking that if they cross into a higher bracket their entire amount of annual income will be taxed at a higher rate.

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This differs from long term capital gains taxes, though, which are taxes on profits you made from selling assets owned for over one year.  For example: shares of Amazon stock that you owned in your TD Ameritrade account for two years and sold during the current tax year for a profit.  The tax rate on this type of gain is also dictated by the amount of federally taxable income you had, but it has a different set of brackets that are not marginal like they are with income tax brackets.  Here are the long term capital gains tax brackets for individual filers in 2018:

Long-term capital gains tax rate Income
0% $0 to $38,600
15% $38,601 to $425,800
20% $425,801 or more

With long term capital gains taxes, an unmarried individual who made $38,600 in federally taxable income would have all of their long term capital gains for the year taxed at 0%.  If that same individual made $38,601, they would pay 15% on all of their long term capital gains for the year.  So when it comes to capital gains taxes, there’s a much larger impact of making that one extra dollar of income, but the impact would only be on the money you made by selling assets owned longer than one year.  Additionally, as of 2018 there were only two income thresholds that would create a change in the tax rate paid, and those were $38,600 and $425,800.

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