A key to tax planning is knowing your marginal tax rate. That's the rate that applies at the margin, to your top dollar of income. Under our graduated income tax rates, as income rises, not only does your tax bill go up but the percentage of that income claimed by the government also increases.
Your marginal rate is controlled by your filing status. For example, single taxpayers pay higher rates for taxable income over $7,150 than someone filing a joint return.
Knowing your marginal rate is essential because it lets you determine how much of any extra earnings - from investments, a raise or moonlighting - you get to keep. It also measures the saving power of deductible expenses. Only if you know your marginal tax rate can you pinpoint what a charitable contribution or business expense really costs you after your tax savings are taken into account.
The bottom line is this: knowing how high your tax bracket really is can greatly energize your tax-planning efforts by enhancing the potential rewards.
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Single Tax Rates |
| 2004 Taxable Income |
Tax |
| Up to $7,150 |
10% of every dollar |
| $7,151 to $29,050 |
$715 plus 15% of the amount over $7,150 |
| $29,051 to $70,350 |
$4,000 plus 25% of the amount over $29,050 |
| $70,351 to $146,750 |
$14,325 plus 28% of the amount over $70,350 |
| $146,751 to $319,100 |
$35,717 plus 33% of the amount over $146,750 |
| Over $319,100 |
$92,592.50 plus 35% of the amount over $319,100 |
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Married Filing Separate Returns Tax Rates |
| 2004 Taxable Income |
Tax |
| Up to $7,150 |
10% of every dollar |
| $7,151 to $29,050 |
$715 plus 15% of the amount over $7,150 |
| $29,051 to $58,625 |
$4,000 plus 25% of the amount over $29,050 |
| $58,626 to $89,325 |
$11,393.75 plus 28% of the amount over $58,625 |
| $89,326 to $159,550 |
$19,989.75 plus 33% of the amount over $89,325 |
| Over $159,550 |
$43,164 plus 35% of the amount over $159,550 |
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Married Filing Jointly & Qualifying Widow(er) Tax Rates |
| 2004 Taxable Income |
Tax |
| Up to $14,300 |
10% of every dollar |
| $14,301 to $58,100 |
$1,430 plus 15% of the amount over $14,300 |
| $58,101 to $117,250 |
$8,000 plus 25% of the amount over $58,100 |
| $117,251 to $178,650 |
$22,787.50 plus 28% of the amount over $117,250 |
| $178,651 to $319,100 |
$39,979 plus 33% of the amount over $178,650 |
| Over $319,101 |
$86,328 plus 35% of the amount over $319,100 |
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Head of Household Tax Rates |
| 2004 Taxable Income |
Tax |
| Up to $10,200 |
10% of every dollar |
| $10,201 to $38,900 |
$1,020 plus 15% of the amount over $10,200 |
| $38,901 to $100,500 |
$5,325 plus 25% of the amount over $38,900 |
| $100,501 to $162,700 |
$20,527.50 plus 28% of the amount over $98,250 |
| $159,101 to $311,950 |
$38,141 plus 33% of the amount over $162,700 |
| Over $319,101 |
$89,753 plus 35% of the amount over $319,100 |
Other than the 10% bracket, each of the tax brackets are adjusted each year for inflation, so that as dollars you earn decline in purchasing power so will the government's take. For example, if the inflation rate in 2004 is 3 percent, then the 15 percent bracket for 2005 would be extended by 3 percent. On a joint return, that would push the top of the bracket from $58,100 to $59,800. (The adjustments are rounded down to the nearest $50.) This means an extra $1,700 would be taxed at 15 percent rather than 25 percent. That would save you $170.00. The top of the 25 percent bracket would also advance, delaying the start of the 28 percent bracket, and so on.
We say these are the "marginal rates" because, as noted below, there's more here than meets the eye. In the table for joint returns, you'll see that taxable income between $58,100 and $117,250 falls in the 25 percent bracket. Does that mean if you make $85,000, 25 percent of it - $21,250 - goes to Uncle Sam? Absolutely not.
Part of your earnings isn't taxed at all. If you claim four exemptions on your 2004 tax return - one each for yourself, your spouse, and two dependent children - that knocks $12,400 off your taxable income because exemptions are worth $3,100 each in 2004. Deductions will reduce taxable income by at least $9,700 more. That's the standard deduction for 2004 joint returns; if you itemize deductions, even more of your income will escape tax. (Note: The 2004 values for exemptions and the standard deduction are higher than those that applied for 2003 because they are increased each year to account for inflation.) So your $85,000 of earnings is pared down to no more than $62,900 of taxable income. Does the government get 25 percent of that amount - $15,725? Nope.
On a joint 2004 return, the tax bill on $62,900 of taxable income will be $9,200. That's about 15 percent of $62,900...and slightly more than 10 percent of $85,000.
Still, you should still keep the 25 percent rate in mind for tax-planning purposes. Because that's the marginal rate, 25 percent of any extra taxable earnings will go to the IRS. And extra deductions - such as a deductible contribution to an individual retirement account or a charitable gift - will produce tax savings at a rate of 25 percent. For example, a $1,000 deductible IRA contribution would knock $250 off your tax bill.
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