Net income provides a more accurate account of the financial status. Here’s why.
What is the marginal tax rate?
The marginal tax rate is the highest percentage of income tax someone pays in a system that assigns tax burdens to citizens according to each one’s individual income. The U.S. utilizes a graduated, progressive tax system that uses marginal tax brackets to calculate what income ranges correspond to what percentage of taxes each person owes. Such a system is designed to ensure that lower wage earners pay less in taxes than higher wage earners do.
Under the progressive tax model, the tax rate increases as income rises and pushes individuals into a higher tax bracket. Each marginal tax rate only applies to all taxable income earned within that bracket, and each dollar earned beyond that range is taxed at the next highest tax rate. That means higher-income earners fall into more tax brackets, paying a higher percentage on all new income earned above the previous bracket.
In the U.S., the lowest tax rate is 10% and the highest is 39.6%. The marginal tax rate is the highest tax bracket that applies to an individual, while her effective tax rate is sum of the taxes she paid in all brackets.
A taxpayer’s marginal tax rate is influenced by her filing status. The Internal Revenue Service describes five of the most common filing statuses: single filers, married individuals filing jointly, married individuals filing separately, head of household, and qualified widow or widower. Some filing statuses increase the income threshold of each tax bracket, meaning that the taxpayer could effectively fall into a lower tax bracket than she would if paying the same amount in a different filing status.
One of those deductions is interest accrued on a home equity line of credit. Find out if you’re getting the most competitive rates using Bankrate’s calculators.
Marginal tax rate example
Sara has an income of $75,000, with a marginal rate of 25%. The next highest tax bracket is 30%. If $75,300 is the cutoff for the 25% bracket and this individual receives a $1,000 raise, this person pays a 30% rate on $700 of the raise.
Sara may choose to donate enough money to charity or itemize enough deductions to reduce the taxable income back to an amount that keeps it within the 25% bracket.