Do You Know What Your “Tax Bracket” Is?

One of the most important numbers to know for your financial well-being is knowing what tax bracket you are in. Knowing this number can be as important as knowing what your income is or maybe even what your FICO score is.

To start off with, what exactly is your “tax bracket?” Your tax bracket may also be referred to as your “marginal tax rate,” a term you’ll hear bandied about by economists and politicians.

To understand “marginal tax rates” you’ll need to understand that your income is not all taxed at the same rate. In the United States, we have a progressive income tax system, which means that higher level of incomes are taxed at a higher rate.

For example, let’s look at a single person whose taxable income (basically taxable income is total income less all allowed deductions and personal exemptions) is $35,000. The first $7,549 of her income is taxed at a 10% rate. Her taxable income from $7,550 to $30,650 is taxed at a 15% rate, and the remaining $4,350 of her income is taxed at a 25% rate. Because the top amount of her income is being taxed at a 25% rate, this 25% rate is her “marginal tax rate” or her tax bracket.

Now, why is this number so important? Well, on the income side, a person’s marginal tax rate is a major factor in determining whether or not it’s worthwhile to pursue earning extra income. For example, suppose our person in the above example had an opportunity to earn an additional $5000 doing some consulting work. Being in the 25% bracket, she’s only going to be able to keep 75% or $3,750 of her earnings. She may very well decide that the hassle factor is not worth her going out and earning the extra $5000 if she can only keep $3,750 of it. On the other hand, if she was only in the 15% bracket, she would be able to keep $4,250 of her extra income and therefore taking on this extra job might be worth it.

On the deduction side, your tax bracket determines the tax savings of deductions such as contributions to 401(k) plans and charitable contributions. For example, a $5000 contribution to an IRA is worth a tax savings of $1,250 to a person in the 25% bracket.

The top tax bracket now is the 35% bracket. If you think that’s high, just remember, back in the 1960′s, the top bracket was 90% and was still as high as 70% until the Reagan tax cuts in the early 1980s.

To sum up, knowing your “tax Bracket” can be a great planning tool. As you prepare your tax return this tax season, be sure to note what your “tax bracket” is. You can find out this number by taking your taxable income and seeing where your taxable income falls on the 2006 Tax Rate Schedule for your filing status. Taxable income is shown on Line 43 of Form 1040, Line 6 of Form 1040EZ, and Line 27. If you are using tax software such as Turbo Tax to prepare your return, you software should calculate your “tax bracket”for you and display it on the tax summary page.