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Financial Literacy - Taxes
OVERVIEW
Understanding your tax bracket
The U.S. tax system is progressive, with six income tax brackets ranging from 10 percent to 35 percent.
Taxes made easy

What's your effective tax rate?

Let's say, for example, that in 2007 your taxable income is $50,000. That amount falls in the 25 percent tax bracket this year, which covers earnings between $31,851 and $77,100. But that does not mean that all your income is taxed at 25 percent.

Your final tax bill is actually figured using the tax rates for the three income brackets into which your earnings fall: the 10 percent and 15 percent brackets, along with your final 25 percent bracket.

So instead of owing the IRS $12,500 (25 percent x $50,000), your final tax bill is actually almost $3,600 less. Here's how it breaks out:

Computing taxes for a single filer with $50,000 taxable income
Earnings Tax bracket Taxes due
$7,825 In the 10% bracket (earnings up to $7,825) = $782.50
$24,025 In the 15% bracket(earnings between $7,826 and $31,850) = $3,603.75
$18,150 In the 25% bracket(earnings between $31,851 and $50,000) = $4,537.50
Total tax bill = $8,923.75

Marginal vs. effective tax rates
As the table illustrates, only a portion of your $50,000 taxable income is taxed at your potentially highest rate.

The tax rate you pay on your last dollar, that 50,000th one in our example, is your marginal tax rate, 25 percent in this case. But your effective tax rate -- the final percentage of federal tax you owe -- is much lower; again, in our example, it comes out to just under 18 percent.

Thanks to the progressive tax rates system, the percentage of money you owe in taxes is actually much lower than the highest rate you pay. So even though your income may put you in a high marginal tax bracket, your actual personal, effective tax rate is lower.

Taxable income only
Remember also that we're talking about taxable income here. Your gross income might be substantially more, but the tax code provides several ways to take that amount down to the $50,000 level used in our example.

Each taxpayer automatically gets a personal exemption to help reduce gross income to a taxable level. You also can claim an exemption for each of your dependents.

Then, if you have a lot of deductions or adjustments, those will further reduce your taxable amount, meaning your tax bill will be even lower.

A quick way to determine your effective tax rate is to pull out last year's tax return and divide the tax you paid by your taxable income. If nothing in your life has changed to affect your tax status, that calculation will give you a rough idea of your own personal tax bracket.

-- Posted: Dec. 17, 2007
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