What is the marginal tax rate and how is it calculated

Tax rates are not always what they seem

When thinking about federal income taxes, many people focus on tax rates and tax brackets. And there’s a good reason for that – at the end of the day, your tax bill is based on the bracket you’re in and the corresponding tax rate. But the US tax system’s use of marginal tax rates makes calculating your eventual tax bill a bit different than it might seem on the surface.

For example, let’s say you have a taxable income of $50,000 and you’re in the 22% tax bracket. Does that mean you owe $11,000 in taxes, which is 22% of $50,000? Not. Your tax bill will be less than $11,000 due to the use of marginal tax rates.

To see why, let’s take a closer look at marginal tax rates and how they affect overall tax liability. We’ll also explore an alternative way of measuring the tax you owe and give some advice on how to reduce your marginal tax rate. In the end, we hope you’ll have a better understanding of how federal income taxes are calculated and how to keep them as low as possible.

What is a marginal tax rate?

The term “marginal tax rate” refers to the tax rate applied to the last dollar of your taxable income. It is essentially the highest tax rate that applies to your income.

You can determine your marginal tax rate by using federal income tax brackets, which are based on your filing status and taxable income for the tax year. The tax rate that applies to your tax bracket is the marginal tax rate. (The tax brackets and rates for tax years 2024 and 2023 are below.)

So, for example, if you’re married filing a joint return with your spouse and have a combined taxable income of $150,000 for the 2024 tax year, you’re in the 22% tax bracket – which means the marginal tax rate. is 22%.

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2024 and 2023 tax installments and rates

Tax brackets are adjusted annually to account for inflation. While the federal income tax rates—currently 10%, 12%, 22%, 24%, 32%, 35%, and 37%—are unaffected by inflation adjustments, the taxable income brackets are changed each year.

For fiscal year 2024, the federal income tax brackets are as follows:

Filing Status in 2024: Single, Married Filing Jointly (MFJ), and Qualified Surviving Spouse (QSS)

2024 Filing Status: Head of Household (HOH) and Married Filing Separately (MFS)

TurboTax Tip: Annual inflation bracket adjustments help minimize “bracket creep,” which is when you get hit with a higher tax bracket even though your income isn’t keeping up with inflation.

If you haven’t filed your 2023 tax return yet, here are the federal tax brackets for that tax year:

Filing Status in 2023: Single, Married Filing Jointly (MFJ), and Qualified Surviving Spouse (QSS)

2023 Filing Status: Head of Household (HOH) and Married Filing Separately (MFS)

How do marginal tax rates work?

When defining a “marginal tax rate,” did you notice that I said it was the rate applied to the “last dollar” of taxable income? But what about the rest of the taxable income?

Here’s the good news: With marginal tax rates, a good portion of your taxable income is usually taxed at lower rates than the rate associated with your tax bracket. This is because income that falls into each category is taxed at that rate. And since the US uses a “progressive” tax structure, rates start low and go up as your income increases.

Example

Let’s go through an example to illustrate how progressive marginal tax rates work.

Let’s say you’re single and have a taxable income of $50,000 in 2024. Based on the 2024 tables above, that puts you in the 242% tax bracket.

Using marginal tax rates for tax year 2024, the first $11,600 of taxable income is taxed at only 10%. So on that portion of taxable income, you owe $1,160 in tax.

The next $35,550 of your taxable income – from $11,601 to $47,150 – is taxed at 12%. This results in a tax of $4,266 on that income.

Finally, the remaining $2,850 of taxable income — from $47,151 to $50,000 — is taxed at 22 percent. That’s $627 in taxes.

When you add it all up, your tax liability equals $6,053 ($1,160 + $4,266 + $627 = $6,053). Note that this is your “base” tax before taking into account any surcharges, credits and previous tax payments.

The tax of $6,053 is much lower than it would be if a “flat” tax of 22% were imposed. If that were the case, the tax base would be $11,000 ($50,000 x 0.22 = $11,000). So by using progressive marginal tax rates instead of a flat rate, you save $4,947 ($11,000 – $6,053 = $4,947).

What is the effective tax rate?

The marginal tax rate only tells you the highest rate that will be applied to your income. And crunching the numbers to calculate your basic tax using progressive marginal tax rates doesn’t always give you a clear picture of the overall rate you’re taxed at. That’s why many people like to calculate an alternative tax rate – their effective tax rate.

The effective tax rate is the percentage of total income that must be paid to the IRS. To calculate your effective tax rate, divide your total tax (line 24 of Form 1040 for tax year 2023) by your taxable income (line 15 of Form 1040 for tax year 2023). This takes into account additional fees and non-refundable tax credits.

To illustrate, let’s start with the example above (you’re a single filer with $125,000 of taxable income in 2024). We have already determined that your tax liability on that amount using marginal tax rates is $23,043. However, let’s add $450 in self-employment tax and a $1,250 child and dependent care credit. This results in a total tax of $22,243 ($23,043 + $450 – $1,250 = $22,243). If we divide this by your taxable income, we get an effective tax rate of about 17.8% ($22,243 ÷ $125,000 = 0.177944).

This is significantly lower than the marginal tax rate of 24% in the same circumstances.

How can you lower your marginal tax rate?

Anything that reduces your taxable income can reduce your marginal tax rate, especially if your taxable income is only slightly above the minimum amount for your tax bracket. If you can reduce your taxable income enough to move into a lower tax bracket, then you will also reduce your marginal tax rate.

So how can you reduce your taxable income? The best way is to make sure you claim all the tax deductions you qualify for. There are many common tax deductions you can take, including:

• Contributions to a traditional IRA
• Student loan interest payments
• Medical and dental expenses
• State and local taxes (up to $10,000)
• Charitable gifts

When choosing between the standard deduction and itemized deductions, be sure to choose the larger one. While you can’t claim both on the same tax return, either will reduce your taxable income.

Another way to lower your taxable income without having to claim a deduction is to put your money into certain tax-advantaged accounts. For example, if you have access to a traditional 401(k) plan at work (or a similar type of employer-sponsored retirement plan), any funds you contribute to the account will be excluded from taxable income that year. (Contributions to a Roth 401(k) plan will be included in your taxable income.)

Certain investment strategies can also reduce your marginal tax rate. For example, selling investments to generate capital losses that can be used to offset capital gains or ordinary income can reduce your taxable income. This strategy is known as “tax loss harvesting”, but you need to be aware of the wash-sell rule.

Staying in the home long enough to meet the rules for a tax-free home sale can also lower your taxable income.

Unfortunately, tax credits cannot reduce your marginal tax rate because they are claimed after your taxable income is calculated. However, non-refundable credits are counted against your total tax, so they can lower your effective tax rate.