Tax Brackets Explained – Making Sense Of Tax Brackets And How They Work
Many people, when they first start learning about taxes, assume that they’ll be paying a flat rate on their employment earnings for tax purposes, and that’s it. This is a common misconception, and in this article, we’re going to educate you about the U.S. government system of tax brackets, what they are, and how they affect what you pay every year in taxes.
Marginal Tax Rate Explained
The way the United States government is set up to operate, people who earn less money per year pay less money in taxes. The people with higher incomes pay more. Take a look at the following diagram, and you’ll understand how marginal taxes work:
Earned Wages: Up to $8,700
Tax Rate: 10%
Earned Wages: $8,701 – $35,350
Tax Rate: 15%
Earned Wages: $35,351 – $85,650
Tax Rate: 25%
Earned Wages: $86,651 and $178,650
Tax Rate: 28%
Earned Wages: $178,651 and $388,350
Tax Rate: 33%
Earned Wages: over $388,350
Tax Rate: 35%
An Example Employment Earnings / Taxable Income Scenario To Better Explain Marginal Tax
Mary works at a steel plant as a head manager and earns $52,456 per year in employment earnings. This puts her in the 25% tax bracket. While this is true, there’s a key part of how marginal tax rates work, which affects the total amount she is responsible for paying in taxes, that we haven’t explained yet.
The first $8,700 of Mary’s employment earnings is taxed at 10%, and the amount she earns between $8,701 – $35,350 is taxed at 15%, and what she makes between $35,351 – $85,650 is taxed at 25%.
So you see, even though Mary officially falls within the 25% tax bracket, she doesn’t pay the full 25% effective tax rate on her employment earnings. Instead, once the calculations are done according to the marginal tax system, Mary only pays a total of 15.29% effective tax rate, with each “bracket” of her taxable income falling into what we outlined in the above tax rate diagram (10%, 15%, 25%).
Self Employed People Face A Higher Tax Burden Than Regularly Employed Individuals
When it comes to tax liability, a self employed person is responsible for paying between 10% and 35% of their total income in federal income taxes. The less you make as a self employed individual, the less you pay in taxes, just like regularly employed people do. The more you make, the more you pay.
As far as Social Security taxes are concerned, a self employed person pays 10.4%. If you compare this to a normal business employee who pays a 4.2% employee contribution, alongside an employers 6.2% contribution, you can see that a self employed person indeed pays more. As a self employed individual, you’re responsible for covering the full breadth of the Social Security tax burden by yourself.
And when it comes to Medicare tax, a self employed person is responsible for paying 2.9%, versus a regular business employee who only has to pay 1.45%, and the employer matches the other 1.45%. So again, the self employed individuals tax liability is higher for Medicare tax too.
Self employed people are faced with a much higher tax burden than regular working Americans, so please keep this in mind if you plan on starting your own business or working for yourself. It may be much harder to “go it alone” than you might have first assumed.
Some Helpful Websites To Better Educate Yourself About How Taxes Work
To learn more about tax brackets and check out some great tax sites, check out the ReviewsRoo category page on taxes! They’ve got tons of useful sites and information.
Also, the following websites will get you off on the right path to educating yourself about your own individual tax circumstance:
US Tax Center – This site has some great tax articles you can use to your advantage
Online And Local Tax Preparation Help – There’s some great tax preparation advice here. Check out this helpful ReviewsRoo article page!