Marginal Tax Rate System

What Is a Marginal Tax Rate System?

The U.S. marginal tax rate is the rate of tax income earners incur on each additional dollar of income. As the marginal tax rate increases, the taxpayer ends up with less money per dollar earned than they retained on previously earned dollars.

Tax systems employing marginal tax rates apply different tax rates to different levels of income; as income rises, it is taxed at a higher rate. It is important to note, however, the income is not all taxed at one rate but rather many rates as it moves across the marginal tax rate schedule.

The goal of the marginal rate is to place a larger share of the burden on the shoulders of the wealthiest taxpayers while lightening the load for those with the lowest incomes.

Key Takeaways

  • The marginal tax rate is the rate of tax income earners incur on each additional dollar of income.
  • The other tax system used in modern economics is the flat tax, where and low-income earners pay the same percentage of their income in taxes.
  • Although earning more money may increase the income tax rate, a larger income will still be taxed at more than one level.
  • In the United States, marginal tax rates range from 10% at the low end to a maximum of 37%.
  • Contrary to popular belief, a higher income bracket will never result in a loss of net income. Each marginal tax rate only applies to income within that specific tax bracket.

Understanding the Marginal Tax Rate System

Every year the Internal Revenue Service publishes an updated schedule for tax brackets, after adjusting for inflation and other factors. There are seven tax brackets, listed below:

Marginal tax brackets and federal income tax rates, 2022.
 Marginal Tax Rate Single/Married Filing Separately Married Filing Jointly  Heads of Household
10% Up to $10,275 Up to $20,550 Up to $14,650
12% $10,275 to $41,775 $20,550 to $83,550 $14,650 to $55,900
22% $41,775 to $89,075 $83,550 to $178,150 $55,900 to $89,050
24% $89,075 to $170,050 $178,150 to $340,100 $89,050 to $170,050
32% $170,050 to $215,950 $340,100 to $431,900 $170,050 to $215,950
35%   $215,950 to $539,900 $431,900 to $647,850 $215,950 to $539,900
37%  Over $539,900  Over $647,850 Over $539,900
Source: Internal Revenue Service.

Income taxes are calculated based on tax filing status (married or separate) and the individual's taxable income. Each tax rate applies only to income within that tax bracket—an individual moving to a higher bracket will never lose money in after-tax income. A single person will pay 10% of their income below $10,275, 12% of any income between $10,275 and $41,775, and so on.

These figures represent only federal income taxes. State and local governments may impose their own income taxes, with different marginal tax brackets.

Flat Tax System

The other tax system used in some modern economics is flat taxes. With flat taxes, the rate does not change, regardless of the individual's income. No matter how much a person makes, they would be taxed at the same percentage.

Example of a Marginal Tax Rate

Sample Marginal Tax Rates
Taxable Income Marginal Tax Rate
Less than $20,000 10%
Between $20,000–$40,000 20%
Between $40,000–$60,000 30%
Between $60,000–$100,000 40%
Over $100,000 50%
For demonstration purposes only.

The above is a simple example of a marginal tax rate schedule. These are not actual tax brackets and are presented only for the sake of demonstration. In this example, a taxpayer earning $20,000 per year will have to pay 10% of their income, or $200. A taxpayer earning $20,001 will pay $200.20: 10% of the first $20,000 of income, and then 20% of the remaining dollar.

Likewise, a person who earns $200,000 per year will have to pay 10% of their first $20,000 in income, 20% of the next $20,000, and so on. The last $100,000 of income is taxed at 50%; in total, they will pay $78,000 in income taxes per year. Their effective tax rate—the percentage of income paid in taxes—is 34%.

If a taxpayer earns more money and moves into a higher income level, marginal tax rates can significantly diminish the benefit of the additional income because it will be taxed at a higher rate. As a result, some believe marginal tax rates are harmful to the economy because they discourage people from working harder to earn more money.

Many people mistakenly believe that marginal tax rates apply to all income, rather than income in a certain bracket. Although earning more money may increase the income tax rate, a larger income will always provide more after-tax income than a smaller one.

Is It Cheaper to Earn Less?

Some people mistakenly believe that a higher income bracket will reduce their net income. While marginal taxes increase with each bracket, these taxes apply only to income within that income bracket.

Marginal Tax Rate Strategies

While the marginal tax system is straightforward, it isn't the only factor in income tax calculations. There are also many tax breaks that can be used to reduce the tax burden on an individual or family.

Broadly speaking, there are two ways to reduce your tax bill: credits and deductions. A tax deduction reduces the amount of income that is subject to taxation. Certain retirement contributions, insurance premiums, Health Savings Accounts (HSAs), and business expenses may be eligible for deduction. Most taxpayers also choose the standard deduction, but in some cases, you can save more by itemizing deductions.

Conversely, a tax credit reduces your final tax bill, and may even offer a tax refund if it falls below $0. Some examples include the Earned Income Tax Credit for certain low-income families, or the Child Tax Credit gives families $2,000 per child.

Each of these tax breaks has its own conditions and requirements, and it's worth taking the time to research so you can save the most on your taxes.

Is Marginal Tax the Same as Tax Bracket?

Marginal tax is related to tax brackets, but they are not the same. A tax bracket refers to the range of incomes that are subject to the corresponding marginal tax. For example, in 2022, there is a marginal tax of 12% on the $10,275-$41,775  tax bracket. Income within that bracket is taxed at 12%, but income below $10,275 is taxed at only 10%.

What Is the Effective Tax Rate?

The effective tax rate is the total amount of taxes paid by a person or corporation, represented as a percentage of their income. This is distinct from marginal tax rates, which apply to income within specific tax brackets.

At What Age Is Social Security No Longer Taxed?

Social Security benefits may be taxed, depending on the recipients' income. This is calculated by taking 50% of a person's Social Security benefits and adding that figure to their adjusted gross income and any tax-exempt interest income. If the sum is more than $25,000 ($32,000 for married couples filing jointly) the recipient must pay taxes on a portion of their benefits, regardless of age.

The Bottom Line

The marginal tax is a complicated and often misunderstood feature of the progressive income tax system. As a person's income rises to a new tax bracket, that income is taxed at a higher rate. However, marginal tax rates are not the only factor in calculating one's obligations, and a skilled accountant can identify many ways to reduce their clients' tax burdens.

Article Sources
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  1. Internal Revenue Service. "IRS Provides Tax Inflation Adjustments for Tax Year 2022."

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