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Withholding: Effective tax rates

Tax BasicsU.S. taxes are progressive. That means the more money you make, the more tax you will pay.

But don't turn down that raise just yet. The progressive nature also means that all levels of income aren't taxed at the same rate. Knowing what your personal tax rate is helps you make sure your withholding is in the right range -- and gives you an easy way to calculate just how much of your raise you get to keep.

Basic Tax Rates: There are five tax rates for 2003 income earned (and upon which you'll figure your tax bill due April 15, 2004). The dollar amount subject to the various tax levels is adjusted for inflation and for each filing category. Click here for the current rates.

Effective tax rates: The division of income amounts into various tax rates means that all your income isn't taxed at one percentage. You're only taxed at each rate on the income in that range.

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For example, if you're a single filer lucky (or good) enough to earn $145,000 in 2003, that whole amount isn't taxed at the 33 percent rate just because your total earnings top out in that range.

Instead, only the portion over $143,500 (the beginning of the 33 percent bracket) is taxed at that rate. The rest of your income is taxed at the accordingly lower rates shown in the tax table. This breaks out, for a single filer, as:

 
$
 7,000
representing 10% taxes
+
$
21,400
representing 15% taxes
+
$
40,400
representing 25% taxes
+
$
74,700
representing 28% taxes
+
$
 1,500
representing 33% taxes

As the table illustrates, only a portion (and in this case the smallest amount) of your hypothetical $145,000 income is taxed at the highest possible rate.

Your personal bracket: Going a step further, when you figure your tax bill using the raw rates above (not counting personal exemptions or any deductions or credits, which we'll discuss in upcoming Tax Basics), you'll come up with a total tax bill of about $35,421 or an effective rate of around 24.43 percent.

That does sound like a lot, until you consider the alternative computation: If the full $145,000 had been taxed at 33 percent instead of on the progressive rate basis, your tax bill would have been $47,850 or around $12,429 higher.

So even though your income may put you in a high tax bracket, your actual personal tax rate is lower. The progressive rates system means that your effective tax rate -- what percentage of YOUR money you owe in taxes -- is actually much lower than the highest rate you pay.

And remember that the percentage of tax owed is figured on your taxable income, not all income. The tax system automatically gives you a personal exemption (and one for each of your dependents) to help reduce your gross income to its taxable leve. Then, if you have a lot of deductions or adjustments that can further reduce your taxable amount, then your tax bill will be even lower.

For a quick look at your effective tax rate, simply pull out last year's return and divide the tax you actually paid by your taxable income. If nothing in your tax status has changed significantly, that'll give a simple ratio for determining your own personal tax bracket.

 

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Tax Basics
Click on the links below to view the seven-part series of Tax Basics
Part One: Withholding
Part Two
Part Three
Part Four
Part Five
Part Six
Part Seven

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