Financial Fellow

   Written by J.P. Wicklein

     Ever wonder what tax bracket you’re in?  To answer this question you need to know your taxable income for the year.[1]   The last taxable dollar you earned in a year will tell you what tax bracket you belong in.  For example, if you had a taxable income of $68,000 during 2008 the last taxable dollar you earned for the year is the $68,000^th dollar.  Looking at Table 1 below you will notice that if you were a single filer the $68,000^th dollar would fall in the 25% tax bracket. Therefore, you are in the 25% tax bracket.  This doesn’t mean, however, that you will pay a 25% tax on the entire $68,000.     

     The taxes you pay each year are based on a progressive tax system.    In a progressive tax system your income is taxed at a higher rate as it grows larger.  As Table 1 below shows, if your taxable income in 2008 is $68,000 the first $8,025 is taxed at 10%, the next $24,524 ($32,550 - $8,026) is taxed at 15%, and the remaining $34,550 is taxed at 25%. 

Table 1

     To determine the actual percent of tax you will pay on your taxable income let’s look at an example.   Table 2 reveals the total taxes a person with a taxable income of $82,000 in 2008 would owe.  Although they fall in the 28% tax bracket, only the last $3,149 ($82,000 - $78,851) is taxed at a rate of 28%.  The bulk of the $82,000 is taxed at a lower rate.  When the total taxes owed ($16,938.25) is divided by the taxable income ($82,000) the average tax rate is actually 20.7%[2]. 

Table 2

Why know your income tax bracket?

     Knowing what tax bracket you fall in will enable you to identify the tax savings that additional deductions (such as contributions to a Traditional IRA or charitable donations) will provide.  For example, assume you have a 2008 taxable income of $37,000.  A portion of your taxable income ($4,450) will be taxed at a rate of 25%.  If you contribute the entire $4,450 to a Traditional IRA you will save yourself $1,112.5 in taxes for the year[3].  If, however, your taxable income was $32,000 a contribution to a Traditional IRA would only save you $667.50 ($4,450 x 15%) in taxes.   Knowing you would only qualify for a 15% tax savings, as opposed to a 25% tax savings, may lead you to consider contributing to a Roth IRA instead[4].

     The ten percent jump between the 15% and 25% tax brackets is the largest increase from one bracket to the next.  Individuals near the border between those tax brackets should pay close attention to any potential deductions.  Although less, the difference between the other tax brackets should also be noted.  Even if you are not in a position to place yourself in a lower tax bracket through deductions, at least now you know what a tax bracket is.