Tax rates aren’t always what they seem
When thinking about federal income taxes, many people zero in on the tax rates and tax brackets. And there’s a good reason for that – at the end of the day, your tax bill is based on the bracket you’re in and the corresponding tax rate. But the U.S. tax system’s use of marginal tax rates makes calculating your eventual tax bill a little different than it might seem on the surface.
For example, suppose you have $50,000 in taxable income and you’re in the 22% tax bracket. Does that mean you owe $11,000 in taxes, which is 22% of $50,000? No. Your tax bill will be less than $11,000, thanks to the use of marginal tax rates.
To see why, let’s take a closer look at marginal tax rates and how they impact your overall tax liability. We’ll also explore an alternative way to measure the taxes you owe, and offer some tips on how to reduce your marginal tax rate. In the end, you’ll hopefully have a better understanding of how your federal income taxes are calculated and how to keep them as low as possible.
What is a marginal tax rate?
The term “marginal tax rate” refers to the tax rate applied to the last dollar of your taxable income. Essentially, it’s the highest tax rate that applies to your income.
You can determine your marginal tax rate using the federal income tax brackets, which are based on your filing status and taxable income for the tax year. The tax rate that applies to your tax bracket is your marginal tax rate. (The tax brackets and rates for the 2024 and 2023 tax years are below.)
So, for instance, if you’re married and filing a joint return with your spouse, and you have a combined taxable income of $150,000 for the 2024 tax year, you’re in the 22% tax bracket – which means your marginal tax rate is 22%.
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2024 and 2023 tax brackets and rates
The tax brackets are adjusted annually to account for inflation. While the federal income tax rates—currently 10%, 12%, 22%, 24%, 32%, 35%, and 37% —aren’t affected by inflation adjustments, the taxable income ranges are modified each year.
For the 2024 tax year, the federal income tax brackets are as follows:
2024 Filing Status: Single, Married Filing Jointly (MFJ), and Qualifying Surviving Spouse (QSS)
2024 Filing Status: Head of Household (HOH) and Married Filing Separately (MFS)
TurboTax Tip: The brackets’ annual adjustments for inflation help minimize “bracket creep,” which is when you’re bumped into a higher tax bracket even though your income doesn’t keep up with inflation.
If you haven’t filed your 2023 tax return yet, here are the federal tax brackets for that tax year:
2023 Filing Status: Single, Married Filing Jointly (MFJ), and Qualifying Surviving Spouse (QSS)
2023 Filing Status: Head of Household (HOH) and Married Filing Separately (MFS)
How do marginal tax rates work?
When defining a “marginal tax rate,” did you notice I said it’s the rate applied to your “last dollar” of taxable income? But what about the rest of your taxable income?
Here’s the good news: With marginal tax rates, a good portion of your taxable income is typically taxed at rates lower than the rate associated with your tax bracket. That’s because income falling within each bracket is taxed at the rate for that bracket. And since the U.S. uses a “progressive” tax rate structure, the rates start low and rise as your income increases.
Example
Let’s run through an example to illustrate how progressive marginal tax rates work.
Suppose you’re single and have $50,000 in taxable income in 2024. Based on the 2024 tables above, that puts you in the 242% tax bracket.
Using the marginal tax rates for the 2024 tax year, your first $11,600 of taxable income is only taxed at the 10% rate. So, for that portion of your taxable income, you owe $1,160 in tax.
The next $35,550 of your taxable income – from $11,601 to $47,150 – is taxed at the 12% rate. That results in $4,266 in tax for that income.
Finally, the remaining $2,850 of taxable income – from $47,151 to $50,000 – is taxed at the 22% rate. That comes out to $627 in taxes.
When you add it all up, your tax liability equals $6,053 ($1,160 + $4,266 + $627 = $6,053). Note that this is your “base” tax before any additional taxes, credits, and previous tax payments are taken into account.
The $6,053 tax is much lower than what it’d be if a 22% “flat” tax was imposed. If that were the case, your base tax would be $11,000 ($50,000 x 0.22 = $11,000). So, by using progressive marginal tax rates instead of a flat rate, you save $4,947 ($11,000 – $6,053 = $4,947).
What’s your effective tax rate?
Your marginal tax rate only tells you the highest rate that will be applied to your income. And running through the numbers to calculate your base tax using the progressive marginal tax rates doesn’t always give you a clear picture of the overall rate at which you’re taxed, either. That’s why many people like to calculate an alternative tax rate—their effective tax rate.
Your effective tax rate is the percentage of your total income that must be paid to the IRS. To calculate your effective tax rate, divide your total tax (Line 24 on your Form 1040 for the 2023 tax year) by your taxable income (Line 15 on Form 1040 for the 2023 tax year). This takes additional taxes and non-refundable tax credits into account.
To illustrate, let’s start with the example above (you’re a Single-filer with $125,000 of taxable income in 2024). We’ve already determined that your tax liability for that amount using the marginal tax rates comes to $23,043. However, let’s add $450 in self-employment taxes and a $1,250 Child and Dependent Care Credit. That results in a total tax of $22,243 ($23,043 + $450 – $1,250 = $22,243). If we divide that by your taxable income, we get an effective tax rate of about 17.8% ($22,243 ÷ $125,000 = 0.177944).
That’s significantly lower than your 24% marginal tax rate under the same circumstances.
How can you reduce your marginal tax rate?
Anything that reduces your taxable income could lower your marginal tax rate—particularly if your taxable income is only slightly above the minimum amount for your tax bracket. If you can drop your taxable income enough to move into a lower tax bracket, then you’ll bring your marginal tax rate down, too.
So, how can you reduce your taxable income? The best way is to make sure you’re claiming all the tax deductions you’re qualified for. There are many common tax deductions that you might be able to take, including:
Contributions to a traditional IRAStudent loan interest paymentsMedical and dental expensesState and local taxes (up to $10,000)Charitable gifts
When choosing between the Standard Deduction and itemized deductions, make sure you pick the one that’s higher. While you can’t claim them both on the same tax return, either one will lower your taxable income.
Another way to reduce your taxable income without having to claim a deduction is to put your money in certain tax-advantaged accounts. For instance, if you have access to a traditional 401(k) plan at work (or a similar kind of employer-sponsored retirement plan), any funds you contribute to the account will be excluded from your taxable income that year. (Contributions to a Roth 401(k) plan will be included in your taxable income.)
Certain investment strategies can reduce your marginal tax rate, too. For example, selling investments to generate capital losses that can be used to offset capital gains or ordinary income can lower your taxable income. This strategy is known as “tax loss harvesting,” but you need to watch out for the wash-sale rule.
Staying in your home long enough to satisfy the rules for a tax-free home sale can also lower your taxable income.
Unfortunately, tax credits can’t reduce your marginal tax rate, since they’re claimed after your taxable income is calculated. However, nonrefundable credits are factored into your total tax, so they can lower your effective tax rate.
