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Your Tax Bracket and What it Essentially
Means to You
Understanding your tax bracket is an important part of making
wise tax planning decisions. Your tax bracket determines how
much you will pay the IRS and how much you can claim in
deductions, and if you fail to understand your tax bracket
correctly, you could end up losing out on a lot of money. Tax
bracket laws can be a little confusing, but taking the time to
learn the basics could pay dividends in the future.
Before you understand your own tax bracket, you need to
understand how tax brackets work in general. Tax brackets are
based on earned income totals and determine the rate of
taxation of that income. The tax brackets ensure that income is
taxed on a sliding scale, with the lowest earners paying the
least amount of taxes. In the US, there are six tax brackets:
10%, 15%, 25%, 28%, 33%, and 35%. Tax brackets are adjusted
every year to account for inflation. In 2006, a person with an
income between $0 and $7,550 would be taxed at 10%, someone
with an income up to $30,650 would be taxed at 15%, up to
$74,200 at 25%, up to $154,800 at 28%, up to $336,500 at 33%,
and a person who makes more than $336,500 would pay taxes at
the rate of 35%.
What tax bracket you is said to be determined by your "last
dollar earned." That does not mean, however, that if the last
dollar you earned puts your income at $30,651 that your entire
income is taxed at the rate of 25%. Even though you would fall
into the 25% tax bracket, your income would be taxed as
different rates as it grew. For instance, if your income was
$40,000, then you would be taxed at 10% for the first $7,550,
then 15% for the income between $7,550 and $30,650, and then
25% for the income between $30,650 and $40,000.
It is important to note that your total taxable income is not
the same as the net total of your salary. You have to add all
of the income you received throughout the year, from work and
from other sources, to come up with your taxable income total.
That means if you have income from investments or inherited
money, you have to include that money in your income to
determine which tax bracket you fall into. Once you know your
taxable income, you also have to figure out how much you can
deduct from your income. When you subtract your deductions from
your total taxable income, the figure you are left with is the
figure that assigns your tax bracket.
If you are close to the borderline in a tax bracket, either up
or down, it is important to plan accordingly. If you are very
close to going up a tax bracket, then consider all of your
other income streams accordingly. Maybe you don't want to sell
your house or sell your stock in this tax year, to avoid
triggering an increase in your taxes. If you are close to
moving down a tax bracket, consider making a charitable
donation that you can claim as a deduction to put you squarely
in the lower bracket. Remember that any shift in your income,
up or down, can affect your tax bracket standing, so take it
into account whenever you are making big financial
decisions.
Going up a tax bracket isn't the end of the world, and likely
won't have a significant effect on your income. However, why
pay more than you have to? Know your tax bracket and keep it
mind during your tax planning, to keep your tax bill to a
minimum.
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