In the world of economics, the marginal tax rate definition is the specific tax rate incurred as income begins to rise. Generally speaking, it can be deduced that the marginal tax rate for any given individual will begin to rise when their income level follows suit. As such, many people consider there to be a direct relationship between marginal tax rates and personal income. A marginal tax rate differs from a flat tax due to the fact that marginal taxation uses the specific income level of an individual as its primary influence.
Calculating a marginal tax rate is as simple as locating the tax bracket associated with your income level and allocating the related percentage of your income to your tax bill.
Marginal Tax Rate Definition
Now that a definition of marginal tax has been established, it is relatively straightforward to observe how this system is put to use in American tax policy today. The standard income brackets the Internal Revenue Service utilizes are a prime example of marginal tax rates in action. According to this bracketed system, individuals in the lowest tiers of income will be required to pay little or no taxes compared to those in the highest income tiers.
Low-income individuals will pay less in a marginal tax plan than those earning significantly more than them. Because of this, many consider the marginal tax system to be the fairest form of taxation policy in existence today. Given the essential data concerning marginal tax brackets and tax percentages, it is relatively easy to begin calculating an individual's marginal tax rate. This process can be accomplished with minimal mathematical skill or experience.
The Role of Adjusted Gross Income
It is important to note here that taxation for each income bracket is not represented as a sum of money owed, but rather, a percentage of an individual's adjusted gross income, or AGI. The AGI is used to calculate income tax rather than gross income due to the fact that this revised figure takes into account the various deductions and credits that some taxpayers are eligible for. Consequently, the AGI is considered a more accurate representation of taxable income.
In the American system of marginal tax rates, it is also important to note that the specific tax percentages mandated by the IRS will change depending upon your specific filing status. For example, a single individual with no children will be forced to pay higher income tax percentage rates than a single mother with three children. This aptly named filing status has a dramatic impact on the amount of tax you owe at year's end.
Exploring 2018 Marginal Tax Rates
According to the IRS, the marginal tax rate brackets for tax year 2018 are 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent and 37 percent. As you can imagine, low-income individuals will be forced to pay taxes at a 10 percent rate, while higher income individuals will pay taxes using a rate of taxation well over 30 percent. Similar taxation concepts related to marginal tax rates apply to businesses and corporate entities. In order to convert a marginal tax rate into an actual dollar value of tax owed, follow the formula in the section below.
Calculating Marginal Tax Amount
First, determine which income bracket you fit in based on your adjusted gross income. You can use the official IRS charts found here in order to properly assess what your annual tax responsibilities may be.
As an example, let us consider the following: an individual filing single currently earning $53,000 in adjusted gross income is set to pay marginal tax at a rate of 22 percent. In order to further explore this amount, you can multiply your AGI by the decimal converted taxable percentage rates to determine exactly how much money you will owe in taxes. Given your current AGI, you will pay a lump sum of $4,453.50, which is required for every single filer in this tax bracket, plus an additional 22 percent on the amount of your AGI that exceeds $38,700. With that in mind, consider the following calculations:
4,453.50 + ((53,000-38,700)*.22) = $7,599.50
This sum represents the amount of money you will be forced to pay in taxes. However, if you have been paying regular taxes as part of your paycheck, you will likely not be required to pay any part of this large debt.
Evaluating Credits and Filing Status
As mentioned previously, a marginal tax rate system uses AGI as its foundation. Your AGI represents the core component of the marginal tax rate formula. Although the simplest approach to filing your taxes is likely to take the information provided on your W-2 relating to income and transferring this into Form 1040, you would likely be missing out on a variety of credits.
The IRS provides individuals with a variety of opportunities to reduce their income based upon legitimate expenses made throughout the year. Although a significant number of revisions have been made to federal tax laws in 2018, self-employed individuals still have the opportunity to deduct a number of expenses related to their work, assuming they can prepare a properly itemized list of them.
Identifying Available Deductions
The IRS offers a standard deduction to all tax filers, regardless of the particular nature of their employment. The standard deduction essentially represents the income amount over which you will begin to be taxed. In 2018, the standard deduction for single filers is $12,000. Although a variety of deduction opportunities have simultaneously been cut, the $12,000 deduction for single filers is nearly double its previous amount, which should allow individuals to benefit greatly during tax season.
Similarly, your filing status can also have a profound impact on the size of your standard deduction. If, for example, you are classified as the head of a household, your standard deduction size increases to $18,000.
Taking the Next Steps
With these ideas in mind, it is critical that you take the time needed to fully evaluate your tax status and ensure that you are not overpaying your fair share of taxes on your return. Fortunately, a number of online tax preparation services are now equipped to thoroughly review your filing documents and ensure that you do not file incorrectly. Marginal tax rate calculators are also widely available online for those who are keen on assessing their potential tax burden in advance of filing season.
That being said, if you are still unsure of what your strategies should be when filing your taxes, it is in your best interest to consult with a tax professional. These individuals can help ensure that you file your taxes correctly, maximizing your deductions and avoiding penalties and filing errors in the process. For many individuals, the cost of consulting a tax professional is well worth the peace of mind and confidence they provide.
- US Tax Center: 2018 Federal Tax Rates, Personal Exemptions, & Standard Deductions
- What is the difference between marginal and average tax rates? | Tax Policy Center
- Tax Brackets & Rates for Each Income Level (2019-2020)
- Tax break - Wikipedia
- U.S. Congress. "H.R. 1." Accessed July 28, 2020.
- Tax Foundation. "2020 Tax Brackets." Accessed July 28, 2020.
- Internal Revenue Service (IRS). "IRS Provides Tax Inflation Adjustments for Tax Year 2020." Accessed July 28, 2020.
Ryan Cockerham is a nationally recognized author specializing in all things innovation, business and creativity. His work has served the business, nonprofit and political community. Ryan's work has been featured at Zacks Investment Research, SFGate Home Guides, Bloomberg, HuffPost and more.