Marginal vs. Average

IMAGINE YOU’RE single, you claim the standard deduction and you have income of $53,000 in 2020. You would be in the 22% federal income tax bracket, but that isn’t how much of your income you lose to taxes.

On the first $12,400 of income, you wouldn’t owe any federal income taxes, thanks to your standard deduction. The next $9,875 would be taxed at 10% and the subsequent $30,250 would be taxed at 12%. That gets you up to $52,525 in total income. It’s only at that point that your income starts getting taxed at 22%. In other words, while you’re in the 22% marginal federal income tax bracket, just $475 of your $53,000 income would be taxed at that rate. Your total federal income tax bill would be $4,722, putting your average tax rate at 8.9% for your $53,000 in gross income and 11.6% for your $40,600 in taxable income.

Your marginal tax rate is crucial for figuring out whether you should buy taxable or tax-free bonds, how much all that mortgage interest is costing you, and whether it makes sense to convert your traditional IRA to a Roth IRA. But your marginal rate isn’t a good indicator of what your total bill will be for the year. For that, you’d want to know your average rate.

Next: Standard vs. Itemized

Previous: Payroll Taxes

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