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Are You Being Misled By Your Tax Bracket?

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A lot of tax talk focuses on tax brackets. But in order to get the full picture of what you hand over to Uncle Sam, you need to consider not your bracket, but your effective tax rate.

Consider the table below of the brackets that apply to the tax returns we're preparing now for 2011.

A single taxpayer earning \$50,000 might assume that their tax rate is 25%. That's not quite right, though. That 25% rate is the marginal rate, the rate at which your next dollar of earned income will be taxed. But it's not the rate at which all of your \$50,000 is taxed.

 Tax rate Single filers Married filing jointly or qualifying widow/widower Married filing separately Head of household 10% Up to \$8,500 Up to \$17,000 Up to \$8,500 Up to \$12,150 15% \$8,501 - \$34,500 \$17,001 - \$69,000 \$8,501- \$34,500 \$12,151 - \$46,250 25% \$34,501 - \$83,600 \$69,001 - \$139,350 \$34,501 - \$69,675 \$46,251 - \$119,400 28% \$83,601 - \$174,400 \$139,351 - \$212,300 \$69,676 - \$106,150 \$119,401 - \$193,350 33% \$174,401 - \$379,150 \$212,301 - \$379,150 \$106,151 - \$189,575 \$193,351 - \$379,150 35% \$379,151 or more \$379,151 or more \$189,576 or more \$379,151 or more

The Right Way to Look at the Tax Table

For those in the 25% bracket, the 10% and 15% rates also apply. Look closely at the table above, and you'll see that your first \$8,500 in income is taxed at just 10%. Then, the next \$26,000 that you earn (from \$8,501 to \$34,500) is taxed at 15%. It's only the amount over \$34,500 that's taxed at 25%.

Even that isn't the full picture, though. (No one ever claimed that deciphering the tax code was simple.) That's because the income you're taxed on isn't all the money you collected over the course of the year.

Not all of your \$50,000 salary is taxed

Let's continue to use our \$50,000 single filer as an example. That income is their gross income, which gets adjusted by various tax rules.

For example, if you made qualifying contributions to IRAs or other retirement accounts, those sums are subtracted. So are alimony payments and some other expenses. These subtractions leave you with your adjusted gross income, or AGI.

Your AGI then goes through its own set of adjustments, as exemptions and deductions are subtracted. Many taxpayers apply the standard deduction to their AGI, while others itemize their deductions. You're allowed to use whichever deduction is greater. You can also apply exemptions to your AGI -- one for yourself and one each for a spouse and/or dependents.

After all this, you're left with your official taxable income -- and it's this amount that counts when you apply the tax brackets.

So our hypothetical filer clearly isn't getting whacked with a 25% haircut on all the money he collected over the year. If your gross income is \$50,000 and your taxable income is \$40,000, this handy tax-rate calculator shows that your effective tax rate is just 12.25% -- even though you're in the 25% tax bracket.

It's all a reflection of the fact that our income tax system is a progressive one, with higher levels of income taxed at higher rates.

Other Income, Other Taxes

Overall, though, our tax system isn't always as progressive as we may think it is. That's because there are other taxes and other rates that factor into the big picture.

If you collect dividend income or have reaped some capital gains on investments, for example, those are currently taxed at a low 15% rate for most people. Within the past few decades, dividends have been taxed at a rate as high as 91%, and capital gains at 40% -- the current rates are extremely low, historically speaking. These low rates are why wealthy folks such as Warren Buffett and Mitt Romney have such low effective tax rates: Much of their income comes from dividends and capital gains.

The bottom is that while there's certainly a lot of room for improvement in our tax system, it has managed to keep our country running for several centuries now. As former Supreme Court Justice Oliver Wendell Holmes, Jr., once noted, "Taxes are the price we pay for civilization."

Longtime Motley Fool contributor Selena Maranjian holds no position in any company mentioned. Click here to see her holdings and a short bio.

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Common lifestyle changes, like getting a job or getting married, can change your tax liability. To avoid being caught off guard by an unexpected tax bill or huge tax refund, you'll need to adjust your withholdings on your paycheck.

Does Everyone Need to File an Income Tax Return?

Not everyone is required to file an income tax return each year. Generally, if your total income for the year doesn't exceed the standard deduction plus one exemption and you aren't a dependent to another taxpayer, then you don't need to file a federal tax return. The amount of income that you can earn before you are required to file a tax return also depends on the type of income, your age and your filing status.

How to Write Off Sales Taxes

The Internal Revenue Service (IRS) permits you to write off either your state and local income tax or sales taxes when itemizing your deductions. People who live in a state that does not impose income taxes often benefit most from this deduction. However, you might also be better off deducting sales taxes instead of income taxes if you make large purchases during the year and your total sales tax payments exceed those for state income tax. You can use either the actual sales taxes you paid or the IRS optional sales tax tables.

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gmydogbud

With Respect: To my mind, Middle Class Americans, need a "Middle Class Party" as the Democrat Party, takes care of the poor and Illegal Aliens, in order to insure their vote. The Repbulican Party, Takes care of Big Business & Illegal Aliens as well. The only ones to be left out are Middle Class American Citizens. Both Parties support employing Illegal Aliens, Sending Jobs Overseas and sending Hundreds Of Billions To Countries & People Who - HATE - US - & - WANT - US - DEAD. Both Parties take Billions from Lobbyists To Vote The Way They Want Them To. We have been sending Democrats & Republicans to Washington, D.C.,for years, to work for the American People only to find out that with them it is only - Money That Talks! They Forced NAFTA & Obama Care on the American People. Obama Care, which neither President Obama nor the Members Of Congress, want for themselves and their famlies! The American Middle Class, Make Their Wishes Known and the Ruling Class, Thumbs Their Nose At Them a & do what their masters tell them to do. They are able to engage in INSIDER TRADING - & - Write The Laws, so that THEY are the only ones able to benefit from Insider Trading - Their Fellow Citizens Are Put In JAIL For Doing The Very Same Thing The Congress Does. I don't think that this is what the Founding Fathers - Had in mind!!

February 04 2012 at 3:15 PM Report abuse rate up rate down Reply
Ken

Do you seriously believe that companies are not going to pass their taxes on to you? The harder you whack them, the harder that whack will land right on you. What would make more sense would be to eliminate corporate income taxes but tax dividends as ordinary income.

February 04 2012 at 3:00 PM Report abuse rate up rate down Reply
DEB

my gross for the year was just under 30,000 after taxes taking and health insurance i couldn't afford to even rent a place and have a car payment insurance all the stuff u have to have to be legal driver anymore in MI then add in electric gas food tv phone i would be in the hole each week thank god for hubby unployment that just ran out. then all these company charge use taxes to use there service which in turns pay the taxes to are goverment. I fell we are triple taxed for everything we buy and use from companies so they can have there 2 or 3rd home. most low income or middle class would just like to keep there home. the rich steal from the poor so they can have more because money is the root of all evil.

February 04 2012 at 2:40 PM Report abuse rate up rate down Reply
larrito

My wife and I make around 50-60k a year. File jointly, no kids. We pay around 12-13%. That seems fair to me. The problem I have always had is why does ANYONE pay a different tax rate? When I was single for many years and was paying 16-18%. I was essentially paying for other peoples children? Oh, yea, I'm sure if your getting all those taxes back because you feel your entitled to help because your contributing to the betterment of the world by making clones of yourselves and the rest of us should pay for it. Fair? Oh, and why does Obamas name get mentioned in every blog as being responsible for everything. Both parties are equally responsible for the greed and corruption that's screwing up this country. This B.S. has been going on for years and years and I would imagin will continue. And as far as I can see, the candidate choices that are coming out on top are proof of that fact. God only knows who the democratic candidates are going to be! I can sure understand why people don't vote. Democracy and capitalism are not the same thing! The rich have run this country for years and nothing short of a revolution will pry their fingers from that cash. If this country were to go down in flames, they would just get on their yachts and head to the Riviera. Do you really think they give a damn about this country. The so called GLOBAL economy is what is doing this. We are not able to compete because the wealthy in this country put their profits ahead of the countries best interests. If the rich really wanted to create jobs, they can do that any time they want. They just want to make sure that they have another puppet in office that bows to their every whim. So they withhold their investment capital and depress the economy therebye making whomever is in office at the time who is not doing what they want him to do look bad. Doesn't really matter if he is democrate or republican. I'm 57 yrs old and just an average guy but I can figure all that out! Dugh. What does the formentioned have to do with the subject of this article? I digress.

February 04 2012 at 12:30 PM Report abuse rate up rate down Reply
LL

Since I am making much less money this year I was concerned that I wouldn't be able to get the kinds of gifts I usually get for my family this year. I thought I would try one of the penny auction sites because I heard that they have the best deals anywhere. I checked out a few sites and it became clear to me that the one that was most reliable and had the lowest prices was at ( http://tinyurl.com/TopBargains ) . To be honest, their prices seemed too low to be true. I tested them out by bidding on an iPad, which my son wanted, but I didn't think I could afford one this year, to my surprise and delight I ended up getting one for \$73. I got it about a week ago and it was brand new and in a sealed box.

February 04 2012 at 11:35 AM Report abuse rate up rate down Reply
bbenz56

Please forward this article to President OPbama, Warren Buffett, MSNBC and all other liberals who keep spreading the lies about how much a secretary or teacher pay in Federal income taxes!

February 04 2012 at 11:06 AM Report abuse rate up rate down Reply
bbenz56

Sorry typo President Obama

February 04 2012 at 11:07 AM Report abuse rate up rate down Reply
Patricia

I may not understand all of this tax crap. That is why I go get my taxes done. I always hope to pay as little as I can. I want a return. I have a disabled family member , give to the Salvation Army. But its a roll of the dice. Go figure some years I get a return others I pay .

February 04 2012 at 10:12 AM Report abuse rate up rate down Reply
juststeve35

Such fraud...

We are a dual income (under 6-figures), family of 5... Just completed our tax return for 2011 and after Child Tax Credits, Mortgage Interest and Healthcare Cost deductions, our effective tax rate is UNDER 10%.

So keep up the scare tactics and rhetoric about the low rates the RICH pay, when the rest of us middle classers are paying similar if not lower rates and 50% of the American population pays NEGATIVE % in Income Taxes: They pay ZERO net taxes and yet still get a refund check.

February 04 2012 at 9:49 AM Report abuse rate up rate down Reply
wos33

Huh ? "....it's managed to keep our country running for several centuries" - Really ? There was NO INCOME TAX prior to 1913 ! Truth is, we did just fine for over 1/2 of our countries history without income of any kind being taxed.

February 04 2012 at 9:34 AM Report abuse -1 rate up rate down Reply
wdcarterjr

About half of the people don't pay federal income tax. I guess that makes them wards of the state.

January 30 2012 at 5:48 PM Report abuse +3 rate up rate down Reply