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It is interesting to know that consumers feel that their income is taxed uniformly throughout. However, this is not true and consumers must understand tax basics. Different amounts are taxed a different taxation rates. Put simply the marginal tax rate for an individual is the tax bracket at which his/her highest portion of income is taxed. So in essence when people talk about their income tax brackets, what they are actually talking about is their marginal tax rates.

Below is an example to help you understand the determination of your tax bracket:

Tax Bracket Calculator

Let us assume that your Gross Wage Income for the 2008 income year to be filed in 2009 is $120,000.00. Now the question arises as to how will the income tax liability on your income be calculated.

• The first $8,350 will be taxed at 10%. $8,351-$33,950 will be taxed at 15%.
• The amount from $33,951-$82,250 will be taxed at 25% and the amount between $82,250-$120,000 will be taxed at 28%.
• This will give you a total tax liability of $835 + $3,840 + $12,075 + $10,570 = $27,320.
• Hence your marginal tax rate in this instance is 28%, because that is the rate at which your highest income is taxed.

One of the main reasons to use a marginal tax rate is to calculate the amount by which a deductions will reduce your income. For instance if your marginal tax rate as in this case is 28%, for every $100 deduction that you claim your taxable income will be reduced by $28 ($100 x 0.28).

Effective Tax Rate

Another interesting concept in determining your tax bracket is understanding what your effective rate of taxes is. The effective tax rate of an individual is the total amount of an individual’s income which has been paid in taxes. Effective rate is calculated as below:

Let us assume the above example. In this case the total taxes due are $27,320. The consumer’s gross income for the year was $120,000. In this case the effective rate would be $27,320/$120,000 = 0.2276 or 22.77%.

When trying to uderstand your tax bracket, always remember that your effective rate will always be lower than your marginal rate owing to the fact that you have been paying taxes at lower rates all the way through to your marginal tax rate.

Combined Tax Rate

Another interesting rate to keep in mind is the combined rate. The combined tax rate for an individual is the marginal tax rate for an individual plus the state tax rate minus any state taxes that can be deducted from your federal tax returns. In the above example the combined rate would be 33% (28% + 5%) should you opt for standard deductions. The main purpose of calculating your combined rate is that it enables you to understand the amount of your non-wage related income that you can keep and what your tax liability is. Put simply it tells you how much of your investment income is going to be taxed and how much can you retain. In this example if you earned $10,000 in investment income, you would be paying $3,300 in taxes and would retain $6,700.

These are some of the basic concepts on how to determine your individual tax bracket and there by calculate your tax liability. So when you consider the fact that your taxable income is exactly what was on your contract, this may be wrong as it is usually your income left over after making contributions to 401(K) account and deducting the tax breaks you are entitled to.

References:

1. So what’s your tax bracket? – CNN Money
2. Federal tax brackets – Money Chimp

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When it comes to understanding taxes most consumers are ready to go and see a tax professional and get them to look after their tax basics. While this might be the easiest way to handle your taxes if they are way too complicated and beyond your scope, consumers who have less complicated tax returns can actually benefit and save time by being a bit more tax-savvy. Understanding tax basics and your taxation liabilities better can help you make informed decisions and could help you save a lot of money over time. We will be discussing certain basic tax issues in this article:

Understanding Taxation: Basic Issues

1. Refunds: This has been an issue with tax payers over the years. At times certain consumers with the same gross earnings in the year could end up getting vastly different tax return amounts from the tax office at the end of the year in the form of a refund. While there could be several reasons for this, one main reason for this is that you could either be paying too much or too little in tax withheld each year. To simplify this for a better understanding of tax – you are basically paying too much; in essence you are giving the government an interest free loan and are reducing your net income which could have been used to meet other requirements. In the event that you are paying too little in tax withheld, you could be liable for an underpayment penalty. One of the important tax basics to understands is that you are either required to pay 90% of your current year’s tax liability to the government by the end of the year or 10% of the previous year’s liability, which ever is smaller.
2. Varying Tax Rates:This is an area where the consumers understanding of tax is limited. Consumers often feel that their income is taxed uniformly throughout. This is however, untrue. Different amounts are taxed at different rates. Put simply, the marginal tax rate for an individual is the tax bracket at which his/her highest portion of income is taxed.
3. Late Payments: Consumers, who file their taxes by the 15th of April but do not make their payments, could be up for a late payment penalty and is a very important tax basic issue worth knowing. The same is also true for consumers who file for an extension. Extensions only allow you to file your taxes after the due date, however you are still required to make your payments to the tax office by the 15th of April. If you have made a partial payment, you could still be liable for a late payment penalty on the rest.
4. Audits: Understanding tax is important to avoid being audited. One of the ways to reduce your chances of being audited is by ensuring that you complete your tax returns correctly and in full. Should you have any questions regarding your tax basics make sure you contact the tax office customer service team and ask them to walk you though any questions you may have. The tax office enforces penalties on incorrect or misleading information.
5. Estimated Taxes: Paying estimated taxes could be a good idea if you are self employed, are expecting a large sum from the sale of a capital item, feel that you do not have sufficient tax withheld to cover non wage related income or even a pensioner. Estimated taxes are due on the following dates: Jan 15, April 15, June 15 and September 15.
6. Determining Your AGI and Taxable Income: When understanding tax, it is important to understand your income as well. Your AGI or Adjusted Gross Income is your gross income minus any allowable or above the line deductions such as voluntary IRA contributions, child-support / alimony payments, heath savings account contributions etc. Once you have determined your AGI, the next step is determining your taxable income which is your AGI minus any exemptions and further deductions. It may be noteworthy that the lower your taxable income the lower your tax liability. Hence taking advantage on tax breaks is a great idea. In addition to this it may also interest consumers to know that credits are better than deductions for the simple reason that credits are a dollar for dollar reduction in the amount of taxes you owe. Simply put, if you have a $500 credit, that would mean that you owe $500 less in taxes.

These are certain basic and simple facts that are important to know about individuals’ taxes. These could help consumers become more tax-savvy and take advantage of tax beaks where applicable.

References:

1. Money Basics: Tax – CNN Money
2. Tax Basics – Bankrate

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