Tax Brackets

Tax brackets are the divisions at which tax rates change in a progressive tax system (or an explicitly regressive tax system, although this is much rarer). Essentially, they are the cutoff values for taxable income — income past a certain point will be taxed at a higher rate.

Tax bracket is a simpler way to say marginal tax rate. A marginal tax rate is the “tax paid on an additional dollar of income” [source: Investopedia]. That additional dollar is also known as your “last dollar.” In a progressive tax system, the portion of your income that does not exceed the upper limit of a tax bracket is your “last dollar.”

Every year about this time, when the Bureau of Labor Statistics (BLS) releases inflation data, specifically the CPI-U, experts from a variety of magazines and newspapers try to predict what the tax brackets will be the following year. This is possible because many figures in the tax laws are based on inflation, such as the standard deduction, contribution limits for Traditional and Roth IRAs, and the size and placing of the tax brackets themselves.

This year, the Tax Foundation is first out the gate with their prediction that everything will essentially remain the same as inflation was a mere 0.19%. When they performed this exercise in predicting the 2009 federal income tax brackets, they were 100% correct. I’m fairly confident that these numbers will be accurate when the IRS officially announces the tax brackets for 2010.

The IRS has released the income ranges for the marginal tax brackets for 2010. The income ranges are adjusted each year to take inflation into account. For 2010, the IRS notes that “recent inflation factors have been minimal” resulting in little or no change for the tax brackets. The LTCG/QD column below refers to the tax rate on long-term capital gains and qualifying dividends for each income range. The income figures below refer to taxable income, which is income after all adjustments to income, standard deduction or itemized deductions, and personal exemptions have been subtracted from total income.

2010 IRS Tax Brackets

Here are the projected federal income tax brackets for 2010:

Tax Bracket Single Married Filing Jointly
10% Bracket $0 – $8,375 $0 – $16,750
15% Bracket $8,375 – $34,000 $16,750 – $68,000
25% Bracket $34,000 – $82,400 $68,000 – $137,300
28% Bracket $82,400 – $171,850 $137,300 – $209,250
33% Bracket $171,850 – $373,650 $209,250 – $373,650
35% Bracket $373,650+ $373,650+

Filing Status

Your tax bracket depends upon two things: your taxable income and your filing status. The options for filing status are:

1. Single
2. Married Filing Jointly
3. Married Filing Separately
4. Head of Household
5. Qualifying Widower with Dependent Child (This can apply to widows as well as widowers.)

Your filing status is based upon your marital and family situation on the last day of the tax year. If on the last day of the tax year, multiple filing statuses apply to you, you are allowed to choose between them.

Many people believe that once you reach a higher bracket you pay the higher tax rate on all the income that falls below that bracket amount as well.  I have actually talked to people who think they need to “get their income into a lower bracket” to avoid paying a higher tax rate, because they think that a higher tax rate would apply to all of the income they earned.

Using the example of the earlier paragraph, many people believe that you would pay $707, not $507, on income of $10,100, assuming that the entire $10,100 is taxed at a 7% rate because the total income is above $10,000.  This incorrect belief is one result of anti-tax arguments.  It is also the basis of many tax-avoidance schemes.  

So, to repeat:  If you enter a higher tax bracket, you only pay the higher tax rate on the amount of income you earn that is in the new tax bracket, not on all of your income.

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