Taxes are always confusing, and marginal tax rates are no exception. Although I am no accountant, here are some clarifications on how to use the 2006 tax bracket table I just posted.
First, it should be noted that it is for taxable income, not gross income. In very broad terms, taxable income is your gross income minus exemptions and deductions. Everybody has the standard deduction ($5,150 for single taxpayers and $10,300 for married taxpayers filing jointly for 2006), and many people have more from things like personal and dependent (kids) exemptions, mortgage interest, and state income taxes. For example, if you were single and had $35,150 in gross income, with the standard deduction you would only have a taxable income of $30,000. You owe no tax on the first $5,150.
But remember, gross income also takes into account interest and capital gains from selling investments in addition to just salary. So estimating your actual taxable income without actually filling out a 1040 form can be a bit tricky.
Second, it’s your marginal tax rate, not your overall tax rate. Marginal tax rate means this is the rate at which your next dollar earned will be taxed. So it’s not retroactive to the dollars you already earned, and you can never make less money after getting a raise.
For example, if you were single and had $30,000 of taxable income, and got a $1,000 raise later to $31,000, your entire $31,000 will not be taxed at the 25% rate (a big jump from 15%!). Only the $350 above $30,650 would be taxed at the 25% rate. Your total taxes would then be:
10% x $7,550= $755 +
15% x ($30,650-$7,550) = $3,465
25% x ($31,000-$30,650) = $87.50
So, if we again take the super-simple case of you being single and taking the standard deduction only, your post-raise gross income would have been $31,000 + $5,150 = $36,150. Paying $4,307.50 of tax on $31,650 of gross income is actually an overall tax rate of only 11.9%.
This is also why when you get a year-end bonus, it seems like the tax bite is enormous. There is no special “tax rate for bonuses” at the federal level, what is happening is that your bonus is being withheld at at higher rate to ensure that you pay enough taxes.
Finally, all this ignores additional hit from state income taxes and payroll taxes like Social Security and Medicare.