Your Tax Bracket and What it Essentially Means to You

Understanding your tax bracket is an important part of making wise tax planning decisions. Your tax bracket determines how much you will pay the IRS and how much you can claim in deductions, and if you fail to understand your tax bracket correctly, you could end up losing out on a lot of money. Tax bracket laws can be a little confusing, but taking the time to learn the basics could pay dividends in the future.

Before you understand your own tax bracket, you need to understand how tax brackets work in general. Tax brackets are based on earned income totals and determine the rate of taxation of that income. The tax brackets ensure that income is taxed on a sliding scale, with the lowest earners paying the least amount of taxes. In the US, there are six tax brackets: 10%, 15%, 25%, 28%, 33%, and 35%. Tax brackets are adjusted every year to account for inflation. In 2006, a person with an income between $0 and $7,550 would be taxed at 10%, someone with an income up to $30,650 would be taxed at 15%, up to $74,200 at 25%, up to $154,800 at 28%, up to $336,500 at 33%, and a person who makes more than $336,500 would pay taxes at the rate of 35%.

What tax bracket you is said to be determined by your "last dollar earned." That does not mean, however, that if the last dollar you earned puts your income at $30,651 that your entire income is taxed at the rate of 25%. Even though you would fall into the 25% tax bracket, your income would be taxed as different rates as it grew. For instance, if your income was $40,000, then you would be taxed at 10% for the first $7,550, then 15% for the income between $7,550 and $30,650, and then 25% for the income between $30,650 and $40,000.

It is important to note that your total taxable income is not the same as the net total of your salary. You have to add all of the income you received throughout the year, from work and from other sources, to come up with your taxable income total. That means if you have income from investments or inherited money, you have to include that money in your income to determine which tax bracket you fall into. Once you know your taxable income, you also have to figure out how much you can deduct from your income. When you subtract your deductions from your total taxable income, the figure you are left with is the figure that assigns your tax bracket.

If you are close to the borderline in a tax bracket, either up or down, it is important to plan accordingly. If you are very close to going up a tax bracket, then consider all of your other income streams accordingly. Maybe you don't want to sell your house or sell your stock in this tax year, to avoid triggering an increase in your taxes. If you are close to moving down a tax bracket, consider making a charitable donation that you can claim as a deduction to put you squarely in the lower bracket. Remember that any shift in your income, up or down, can affect your tax bracket standing, so take it into account whenever you are making big financial decisions.

Going up a tax bracket isn't the end of the world, and likely won't have a significant effect on your income. However, why pay more than you have to? Know your tax bracket and keep it mind during your tax planning, to keep your tax bill to a minimum.

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