Marginal vs. Average Tax Rates

Imagine you’re single, you claim the standard deduction and you have income of $50,000 in 2017. You would be in the 25% federal income tax bracket, but that isn’t how much of your income you lose to taxes.

On the first $10,400 of income, you wouldn’t owe any federal income taxes, thanks to your $6,350 standard deduction and your $4,050 personal exemption. The next $9,325 would be taxed at 10% and the subsequent $28,625 would be taxed at 15%. That gets you up to $48,350 in total income. It’s only at that point that your income starts getting taxed at 25%. In other words, while you’re in the 25% marginal federal income tax bracket, just $1,650 of your $50,000 income would be taxed at that rate. Your total federal income tax bill would be $5,639, putting your average tax rate at 11.3% for your $50,000 in gross income and 14.2% for your $39,600 in taxable income.

For high-income earners, their true marginal tax rate may differ from the rate for the top tax bracket that they’re in, because each additional dollar of income also causes lost tax benefits, such as a reduction in the amount they can claim in itemized deductions and personal exemptions.

Your marginal tax rate is crucial for figuring out whether you should buy taxable or tax-free bonds, how much all that mortgage interest is costing you, and whether it makes sense to convert your traditional IRA to a Roth IRA. Most taxpayers pay federal taxes at a 15% marginal rate or lower. But your marginal rate isn’t a good indicator of what your total bill will be for the year. For that, you’d want to know your average rate.

Next: Standard vs. Itemized Deductions

Previous: Payroll Taxes

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