Income tax buckets
A visual explanation of how our income taxes work
Good morning!
A lot of people I talk to don’t understand how our income taxes work.
Many believe if your taxable income puts you in the 24% tax bracket, you pay 24% on every single dollar of your income to the IRS.
I’ve written about this before:
Let's Talk Taxes
Today I’d like to revisit this topic with a visual which I hope will better explain things.
Check this out:
The image above is from a spreadsheet created by Jeremy Eppley at Silverstone Financial.
While you might want to click the image above to see a larger version, it shows the income taxes for a person filing single in 2024 and earning $83,586.
However, using the 2024 standard deduction for a single filer which deducts $14,600 from their total income, only $68,986 of their income is taxable.
This amount of taxable income puts this person in the 22% “marginal” income tax bracket. More on that in a minute…
Thankfully, they’re not going to pay 22% on all their income.
In the example above, this person pays 10% on their first $11,600 of earnings. This results in tax owed of $1,160. This is the first green bucket in the spreadsheet.
It’s full - as the image above shows - so any additional income spills over into the next bucket…
Which means they’ll owe 12% on the next $35,549 of their taxable income which equals $4,266. This is the 2nd green bucket in the spreadsheet.
Once it’s full, any additional income spills over into the next bucket…
Finally, they’ll owe 22% on only $21,837 of their income which amounts to $4,804. You can see this bucket is only partially filled which means we’ve accounted for all their income.
If you add up the separate tax amounts from the 3 buckets/brackets that this person’s income falls into, you get a total tax bill of $10,230.
This person’s effective - or average - tax rate is 14.8% even though some of their income falls in the 22% tax bracket.
You calculate your effective tax rate by dividing your total tax bill - $10,230 in this example - by your total taxable income - $68,986. This is how we arrive at an effective tax rate of 14.8%.
But their “marginal” tax rate is 22%.
This means if they earned an additional dollar of taxable income this year, it would be taxed at 22%.
Because this bucket hasn’t been filled up yet.
I think the buckets in the visual help clarify how this works.
What do you think?
Is this helpful?
This isn’t tax advice. Please speak with your tax preparer about your specific situation.
Here’s the same visual for someone married filing jointly in 2024 that earned $330,000:
As you can see above, that puts $99,752 of their taxable income in the 24% tax bracket.
So their marginal rate is 24% but their effective tax rate is only 19.4%.
The 19.4% is their average - or blended - rate across all of the tax buckets their income falls into.
If our income taxes were regressive, you’d see what bracket your taxable income falls in and you’d pay that rate on all your income. Back to your first dollar.
This is how many people assume our income taxes work.
Since we have a progressive income tax system, you only pay the rates for the portion of your taxable income that falls within each tax bracket. Or bucket.
Here are the 2024 income tax brackets for reference:
However, not all our taxes are progressive.
Take Medicare IRMAA, for example.
Here are the current IRMAA brackets for 2024:
If your taxable income goes just $1 into the next higher IRMAA bracket, you’ll pay the full amount of the higher Part B & D premium adjustments.
There are no effective rates when it comes to IRMAA.
And to add another layer of complexity, your income this year will impact your Medicare premiums 2 years in the future.
Which is why tax planning is increasingly becoming a focus of my work with clients as they approach and transition into retirement.
Hopefully you now have a clearer understanding of how your income taxes work.
If you have any questions about this or there’s anything else you’d like to discuss, please let me know.
Simply reply or leave a comment.
Links & Things
Please read this recent press release from the Social Security Administration:
If you setup an online login for the SSA prior to September 18, 2001, you might receive an email or other communication about updating your login to their more secure Login.gov system.
This is legitimate.
However, press releases like this also invite scammers and fraudsters to attempt to contact you in the hopes of getting your personal information.
Be skeptical and stay safe…
Curious which Americans are happiest?
Check out this infographic to see for yourself.
Thoughts? Suggestions?
Hit reply or leave a comment and share your thoughts…
Until next Wednesday,
Russ