Tax Bracket, Tax Rate, What's the Difference?1 min read

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It’s not a trick question, there is a difference between your tax bracket and your tax rate.  Your tax rate indicates your tax liability in relation to your total income but for planning purposes, you will also want to be aware of your tax bracket.  As an example, to stay within the limits of a particular tax bracket you may plan to spread a Roth conversion over the span of several years.
Notably, the main difference between the two is that a tax bracket is a range of income to which a specific tax rate applies, while the percentage of your income that you actually pay in tax is referred to as your tax rate.  In other words, not ever dollar is taxed the same.  Tax bracket indicates the rate of tax on the last dollar you made during the tax year and the actual amount you paid on all your taxable income is reflected in your effective tax rate.
Taxable income within the 25% bracket for 2016 is between $37,650 and $91,150 for a single person.  But say, for example, the tax they pay is less than 25% of their income.  This is due to the fact that tax on the income below $37,650 is calculated using the rate that applies in the 10% and 15% brackets and only the income within the 25% bracket will be taxed at 25%.
Therefore, if your 2016 taxable income is $40,000, only $2,350 is taxed at 25% and the remainder is taxed at 10% and 15%.  This leads to a “blended” overall rate and the result is a tax bracket of 25%, and an effective tax rate that is less.
Contact us for advice that can affect both your rate and your bracket.

By Simons Bitzer



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