Marginal vs. Average Rates

IMAGINE YOU’RE SINGLE, you claim the standard deduction and you have income of $52,000 in 2018. 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 $12,000 of income, you wouldn’t owe any federal income taxes, thanks to your standard deduction. The next $9,525 would be taxed at 10% and the subsequent $29,175 would be taxed at 12%. That gets you up to $50,700 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 $1,300 of your $52,000 income would be taxed at that rate. Your total federal income tax bill would be $4,739.50, putting your average tax rate at 9.1% for your $52,000 in gross income and 11.8% for your $40,000 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. In 2018, most taxpayers will pay federal taxes at a 12% marginal rate or lower. 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 Deductions

Previous: Payroll Taxes

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