Marginal tax brackets are a frequently misunderstood topic. It’s not uncommon for someone to say they don’t want a raise because it will put them in a higher tax bracket and force them to pay more taxes on the money they earn. They believe they would be better off not receiving the raise in the first place. This is a common misconception, but thankfully, that is not how marginal tax rates work.
For example, let’s say you receive a salary increase that takes your final salary from the 12% tax bracket to the 22% tax bracket. Your raise doesn’t place all your income to the 22% tax bracket. You only pay the higher taxes on the amount that falls within the 22% tax bracket.
We’ll show you the income levels for each tax bracket and some examples of income tax brackets and how marginal taxes actually work. You can use these to calculate your effective tax bracket or the amount of taxes you actually pay on all your income.
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Understanding Marginal Tax Rates
Tax planning is a fundamental aspect of financial planning. To fully understand how tax planning works, it’s important to understand what your marginal tax rate is.
A marginal tax rate systems is a “gradual” tax schedule. In effect, the amount of taxes you pay increases as your income increases. The IRS places the marginal tax rates into brackets, making the marginal tax formula easier to understand and compute by hand.
Let’s look at the 2023 federal tax brackets to see this in action.
What Are Tax Brackets?
Understanding your income tax bracket is the basis of sound tax planning. For federal tax purposes (and for most states that do not have a flat income tax), income tax brackets state the amount of tax that you’ll pay for income earned within that bracket.
For example, in 2023, a married couple (filing jointly) making less than $22,000 is taxed at 10% of their income. Thus, they’re in the 10% tax bracket.
Once they make more than $22,000, they are taxed at 12% for their income above $22,000. (They will still be taxed at 10% for the first $22,000 they earn.) Now, they’re in the 12% tax bracket and will be until they earn more $89,450. Then, they’ll move up to the 22% tax bracket, where they’ll pay 22% on any income above $89,450, and so on.
Once you determine what income tax bracket you’re in, then your marginal tax rate is simply the applicable tax on your next dollar of earned income. For example, if you are a single filer in the 22% tax bracket, then your marginal tax rate is 22%. For every additional dollar you earn over $44,725, you’ll pay an additional 22 cents in tax. Conversely, for each dollar of decreased taxable income, you’ll save 22 cents in tax.
What Does the Marginal Tax Rate Mean?
Now that we know what the marginal tax rate is, we can apply it to tax planning. You can use your tax rate to evaluate every decision for tax savings and after-tax financial impact.
Financial decisions that might be very wise in one tax bracket (such as accelerating or postponing taxable income) might not be prudent in another.
Let’s use tax-loss harvesting as an example.
Suppose you bought a stock six months ago. Since then, a series of developments and bad earnings reports has convinced you to sell.
You’re trying to decide whether to sell the stock at the end of the year or at the beginning of next year.
If you’re in the 32% tax bracket but expect to be in a lower bracket next year, you might want to sell now. But, if you’re in the 12% tax bracket but expect to be in a higher tax bracket next year, you might want to wait to sell until next year, so you can lower your tax burden when it’s highest.
This is a basic example of how marginal tax brackets affect tax planning.
How Do I Find My Marginal Tax Rate?
To find your previous year’s marginal tax rate, you only need your tax return (Form 1040 or Form 1040-SR). Look at Line 15, which correlates to taxable income. Once you determine your taxable income, you can refer to the tax brackets below to determine your marginal tax bracket. Keep in mind your filing status (single, married filing jointly, married filing separately or head of household), particularly if your status recently changed.
2023 Federal Tax Rates, Standard Deductions and Capital Gains
Here are the current tax rates.
You can use this information for short and long-term tax planning. Knowing how your tax rate will change can help you time important decisions like Roth IRA conversions, selling stocks for short-term or long-term capital gains, making charitable donations and other moves that will impact your tax return.
2023 Federal Income Tax Brackets
| 2023 Marginal Tax Rate | Single Individuals Taxable Income Above | Married Filing Jointly or Qualified Widow(er) Taxable Income Above | Head of Household Taxable Income Above | Married Filing Separately |
|---|---|---|---|---|
| 10% | $0 | $0 | $0 | $0 |
| 12% | $11,000 | $22,500 | $15,700 | $11,000 |
| 22% | $44,725 | $89,450 | $59,850 | $44,725 |
| 24% | $95,375 | $190,750 | $95,350 | $95,375 |
| 32% | $182,100 | $364,200 | $182,100 | $182,100 |
| 35% | $231,250 | $462,500 | $231,250 | $231,250 |
| 37% | $578,125 | $693,750 | $578,100 | $346,875 |
2023 Standard Deductions
The standard deduction is how much taxpayers can deduct from their income before paying income tax. You can choose to apply the standard deduction or itemize deductions, whichever results in the best tax return for your situation.
The Tax Cuts and Jobs Act of 2017 substantially increased the standard deduction, removed personal exemptions and decreased the amount taxpayers could deduct for SALT taxes (state and local taxes, including state and property taxes). Many of these changes will expire in 2025, and it may become easier for many people to claim deductions. Here are the current standard deductions:
| Filing Status | Standard Deduction Tax Year - 2022 | Standard Deduction Tax Year - 2023 |
|---|---|---|
| Single | $12,950 | $13,850 |
| Married Filing Separately | $12,950 | $13,850 |
| Married Filing Jointly | $25,900 | $27,700 |
| Head of Household | $19,400 | $20,800 |
It only makes sense to itemize tax deductions if they will be larger than the Standard Deduction.
2023 Long-Term Capital Gains Tax Rates
When you sell certain property or investments for a profit, you owe capital gains tax.
If you held your investment for less than a year, you’ll pay short-term capital gains tax. The IRS assesses these taxes as regular income and taxes them at your marginal income tax bracket.
You’ll pay long-term capital gains tax on investments that you held for longer than a year. They are taxed at the following schedule:
| 2023 Long-Term Capital Gains Tax Rate | 0% | 15% | 20% |
|---|---|---|---|
| Single Filers | $0 - $44,625 | $44,625 - $492,300 | Over $492,300 |
| Married Filing Jointly | $0 - $89,250 | $89,2501 - $553,850 | Over $553,850 |
| Head of Household | $0 - $59,750 | $59,750 - $523,050 | Over $523,050 |
| Married Filing Separately | $0 - $44,625 | $40,401-$523,050 | Over $523,050 |
Some investments, such as gold or collectibles, do not follow the capital gains guidelines. How you’ll pay taxes on them depends on whether you’ve held them long- or short-term.
Applying Federal Tax Rates to Your Situation
As you can see from the above federal tax bracket table, this is a gradual tax system. You won’t pay the corresponding income tax rate on all your income – just on the income you earn above each tax threshold.
For example, if you are married filing jointly and receive a raise from $89,450 to $90,000, the 22% tax bracket will not apply to all of your income — it will only apply to income earned above the 12% threshold (in this case, $550). These gradual tax rates add up to your effective tax rate.
How to Calculate Your Effective Tax Rate
Here’s an example to show how effective tax rate calculations work.
Let’s say you’re a married couple filing jointly with $100,000 of taxable income (after deductions and exemptions). You’re in the 22% tax bracket but you don’t actually pay $22,000 in federal taxes.
Instead, you pay:
- 10% on the first $22,000 of income: $2,200
- 12% on income over $22,000 but less than $89,450: $8,094
- 22% on income from over $89,450 but less than $178,150: $2,321
In total, you’d only pay $12,615, before factoring in deductions.
So, in this example, the weighted, or effective tax bracket, is 12.615%.
Note: This is a simplified example and does not include any deductions, state taxes or local taxes. Use a state tax calculator when you file your taxes, or file with tax software. Most tax software programs, including MilTax, TurboTax and H&R Block, can calculate state taxes, deductions, tax credits and more.
MORE: The Military Wallet Readers save $25 on H&R Block Tax Services!
Using Marginal Tax Rates for Tax Planning
You can use your knowledge of the marginal tax rate system to reduce your taxes if you are near one of the tax bracket limits. All you need to do is bring your final number below the threshold.
For example, if you are married filing jointly and earn $91,450, you can contribute $2,000 to your 401(k) and avoid paying the higher tax rate on $2,000.
The marginal tax bracket on the amount over $89,450 would be 22%. By dropping back down to the 12% tax bracket, you can avoid paying 10% extra in taxes paid for that $2,000. So your 401(k) contributions in this situation would save you $200 in federal taxes.
While this is a simplified example, you can see that the tax savings can easily add up, depending on how much you can shave from your marginal tax rate.
Marginal Tax Rate Case Study
Let’s consider a young couple, Joe and Jane Doe, who want to convert their traditional IRA to a Roth IRA, to avoid paying taxes on their earnings. It makes sense to do this if they expect to be in a higher tax bracket in their retirement years when they are drawing from their IRA.
However, they’ll have to pay taxes on any traditional IRA funds that they convert, so it’s better to make the conversion when they’re in a lower tax bracket.
So, let’s calculate their tax bracket. Joe is a homemaker and Jane is an O-3 in the Air Force. She’s been in for six years, so her monthly income is $6,780.30. Assuming they have no other taxable income, this puts their 2023 annual taxable income at $81,364 (rounded up to the nearest dollar). So, they’d be in the 12% tax bracket, assuming they have no tax exemptions or deductions that would reduce their taxable income, (which is what we’ll assume here for simplicity’s sake).
The Does’ traditional IRA account has $50,000 in it.
Joe and Jane want to convert as much as they can but stay within their current marginal tax rate.
A quick look at the tax tables shows that they’ll remain in the 12% bracket until their income reaches $89,450. So, they could convert $8,086 this year at 12%. If they converted any more of their IRA this year, they would pay 22% of every dollar over $8,068.
Let’s look at their options:
- They could convert the entire amount this year. They would pay a total of $10,191.40. This includes $970.32 for converting $8,086 at the 12% rate plus $9,221.08 for converting the remaining $41,914 at the 22% rate.
- They could convert up to the 12% limit without going over. In doing so, they would pay $970.32 in taxes this year. They could revisit this in future years to take advantage of their 12% tax bracket. If they could convert the full amount at the 12% bracket, they would pay a total of $6,000 in taxes, saving them about $3,220 compared to a one-time conversion.
- They could choose not to convert at this time. They could make this for any number of reasons. Perhaps they found a better investment opportunity, or maybe the tax rules changed. Or, perhaps there’s an upcoming deployment that allows them to convert some of their money at the 10% bracket.
Again, this is a simplified example. When you’re considering your situation, be sure to factor in tax exemptions, tax deductions and any tax-deferred contributions to a traditional IRA, Thrift Savings Plan, or 401(k).
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Monica Kueny says
Thank you very much for your informative review of tax brackets, as well as tax planning based on brackets, whether current or expected in the future. I’m 60, and just starting my financial education beyond the basics. I suppose some would say tax planning is basic financial knowledge, but not for me unfortunately! I appreciate your clear explanation and examples. Thank you again, and Happy Holidays to you and your family!