When your accountant says you’re in the 25 percent tax bracket, it means 25 percent of your taxable income (ignoring deductions) is subject to taxes. Right?
Tax Brackets, explained
That’s a common misunderstanding of how tax brackets work. (For simplicity, we’re going to ignore tax deductions throughout this article.) Here’s the real skinny:
- 0 to $8,925: 10%
- $8,926 to $36,250: 15%
- $36,251 to $87,850: 25%
- $87,851 to $183,250: 28%
And so on. So when you hear people say, “I’m in the 25 percent bracket,” it means they’re taxed 25 percent only on the part of their taxable income that’s above $36,250.
Afraid of a higher tax bracket?
Which brings up another misunderstanding: Many people at tax time live in fear that some extra money they earned will “put me in a higher tax bracket.” If you’re among them, you might picture yourself paying 28 percent, instead of the usual 25 percent, just because your taxable income is a little over $87,850.
You will pay 28 percent, but only on the exact amount above $87,850. So if your taxable income is, say, $88,000, you pay 28 percent just on the $150 difference, which comes to a not-so-frightening $42.
You may have known all this already. If so, take a bow. If not, welcome to the Smart-About-Tax-Brackets Club.