It may seem confusing trying to understand the complexities of the tax code but knowing what your marginal tax rate is, is an important part of filing your taxes. While it might not be everyone’s favorite topic to discuss, understanding your marginal tax rate is key to managing your finances and saving money.
Simply put, marginal tax rate is the rate of tax you pay on each additional dollar of income. To calculate your marginal tax rate, the amount of tax you’ll pay on an additional dollar earned is divided by that dollar amount. This rate assists in determining the amount of tax you’ll pay on any given amount of earned income.
Marginal tax rate is distinct from an individual’s effective tax rate which is the average rate at which an individual’s income is taxed. It is determined by dividing the total amount of tax paid by a person’s taxable income for the year. For instance, if someone has only earned $10,000 in taxable income and their total tax payment for the year is $1,500, then their effective tax rate would be 15%.
Marginal tax rate is different in that it is a “progressive” tax rate system. This means that the tax rate increases as taxable income increases. Therefore, a person with a higher taxable income would likely pay a higher rate of tax on additional income than someone with a lower income. For example, if you earn $50,000 annually and your marginal tax rate is 25%, that means the first $50,000 you’ve earned would be taxed at 25%.
Understanding your marginal tax rate is important. It can help you identify how much more tax you’ll need to pay if your income increases. It can help you decide whether it’s more beneficial for you to use deductions or credits to lower your taxable income. Knowing your marginal tax rate can help you plan your finances and budget accordingly so that you can maximize your savings.
Conclusion
In summary, the marginal tax rate is the rate of tax you’ll pay on every additional dollar you earn. To better manage your taxes, it’s important to understand your marginal tax rate as well as your effective tax rate in order to make the most of your income tax deductions and credits. Knowing your marginal rate can give you an estimate of your income taxes before actually filing your taxes. By having a better understanding of your marginal tax rate, you’ll be in a better position to plan and budget your finances in the future.