What is Marginal Tax Rate?

Marginal tax rates are like the difficulty levels on a treadmill...

A treadmill might have ten different levels, with each one getting progressively harder as you go. By the time you’re at level 10 (or earning an income subject to the highest tax rate), you’ve hit the highest level of difficulty. But you only get to the hardest level if you can run that fast.

The United States has a progressive income tax system. As your income rises, you pay a higher percentage of your earnings in taxes. For fairness, tax policy is based on the idea that people who earn higher incomes can afford to put more of their income toward taxes. This system helps to ensure that low-income individuals aren’t paying so much in taxes that they are left without enough to live on.

But thanks to marginal tax rates, just because you are in a higher tax bracket doesn’t mean you are paying the same rate for all of your income. Instead, you pay taxes on each dollar you earn at the rate of the tax bracket into which it falls. The only people who pay one rate on all of their income are those in the lowest income tax bracket.

For example, the highest federal income tax rate (37%) applies to a single person earning $539,901 or more in 2022 (in 2023, this will increase to $578,126). People with a taxable income of $600,000 would fall into that tax bracket, but to be clear, they wouldn’t pay a 37% income tax rate on all of their income, only on the portion above $539,901. They would have some of their income taxed at each of the seven tax rates. And for the first $10,275 they make, they would pay the same rate as someone with an annual income of $5,000, which is the lowest rate of 10%.

Marginal tax rates apply a bit differently depending on how you file your taxes — whether you’re single, married filing jointly, married filing separately, or the head of the household. If you’re married and filing either jointly or separately, the income threshold for each tax bracket is higher. So for the highest tax bracket, rather than paying 37% on any dollar $539,901 or higher, married couples don’t pay a 37% tax rate until their combined taxable income reaches $647,851. Additional taxes may also apply to income, such as FICA and state taxes.

Keep in mind your taxable income isn’t determined entirely by your salary. First, your taxable income could go up if you have money coming in from anywhere else. Your taxable income includes your wages and any bonuses you get at work. It also includes any income you might have from any freelance work or side jobs, unemployment benefits, as well as any profits, dividends, or interest you earn from investing.

Don’t worry, taxable income can also be reduced. That means you can lower how much you pay in taxes. When you’re filing your taxes, you can either take the standard deduction (a fixed amount that the government allows everyone to deduct automatically) or itemized deductions (meaning you figure out what deductions you qualify for).

Usually, you would only itemize if your deductions will exceed the amount allowed for the standard deduction. The standard deduction for 2022 taxes (which are due in spring 2023) is $12,950 for single filers and married couples filing separately and $25,900 for married couples filing jointly. For 2023 taxes (which are due in spring 2024), those numbers will increase to $13,850 and $27,700, respectively.

Some common deductions that you might be eligible for include contributions to a health savings account or Individual Retirement Account, student loan interest payments, mortgage interest payments, property taxes, and donations to charities.

Being familiar with the marginal tax rate system is important because it can give you a better understanding of how your financial decisions might affect your taxes. For example, you can figure out whether getting a higher-paying job might push you into a new tax bracket, or whether making a tax-deductible purchase might push you down into a lower tax bracket.

Individuals and businesses can also use the marginal tax rate system to help make financial decisions. For example, a business owner might invest in their business or their employees toward the end of the year, knowing that decision will help to push them into a lower tax bracket, lowering their total tax burden for the year.

For the 2022 tax year (meaning the taxes that are due in spring 2023), there are seven tax brackets with seven different tax rates.

The marginal tax rates are:

• 10%
• 12%
• 22%
• 24%
• 32%
• 35%
• 37%

Let’s take a look at what those tax brackets look like:

When it comes to taxes on your income for 2023 (meaning the taxes you probably’ll file in spring 2024), the marginal tax rates remain the same, but the income thresholds for each bracket increase slightly. Here’s what those brackets will look like:

While marginal tax rates are the tax rates that you pay on different parts of your income, an effective tax rate is the percentage of your total income that you owe the IRS for that year.

Let’s say you’re single, and you made $50,000 in 2022. After taking the standard deduction of $12,950, your taxable income is $37,050. Your taxable income falls into two tax brackets: 10% and 12%. After calculating the taxes owed using the two different rates, the total amount of income tax you’ll pay the IRS for the year is $4,240.50.

To calculate your effective tax rate, divide your total tax bill by your pre-tax income (so $4,240.50 divided by $50,000). As a result, your effective tax rate is 8.5%. Your effective tax rate is a much more accurate representation of the percentage of your income that you pay in taxes. As you can see from our example, having a salary of $50,000 theoretically puts you in the tax bracket for the 22% marginal tax rate. But once we account for the standard deduction and calculate the amount you’ll pay in taxes in each of the brackets, the effective rate you pay in taxes is far lower than 22%.

You can also see from our example what an impact the standard deduction can have on your total tax liability. Imagine if there were no standard deduction, and you didn’t qualify for any individual deductions. You would have to pay income taxes on the full $50,000 you made in 2022. You would have paid 22% on the top chunk of your income, 12% on the middle piece, and 10% on the bottom part. Instead of paying $4,240.50 in income taxes, you would have paid $6,617 — over $2,376.50 more than when you use the standard deduction. Your effective tax rate in this situation would be around 13.2% instead of the 8.5% you paid.

Robinhood does not provide tax advice. Please consult with a tax professional regarding your personal circumstances.