We’ve all heard people say they don’t want to make an extra dollar because they will have to pay higher taxes on their income. While it may be true that the additional dollar they earned could be taxed more, it doesn’t affect their entire earnings. This article from Dr. Thia, MPower Co’s Director of Education, walks you through the difference between average tax rate and marginal tax rate to explain how that thinking is flawed. 

This article is based on the 2022 tax rates; however, this article is applicable to anyone wanting to better understand how their marginal tax rate and average tax rates work. 

What the IRS Says About the Tax Deadline for 2022

It is tax preparation season and the time of year when we realize that understanding everything about our income tax system would be impossible.  When you understand your average tax rate and marginal tax rate it helps you make better-informed tax management decisions.

The federal income tax system is complex and filled with exceptions and technicalities.  I’ll illustrate that point with what should be a simple announcement of the filing date for 2021’s federal taxes in 2022.  The Federal income tax filing deadline is April 15 in 2022, right? No, it is April 18, and listen to this explanation from the IRS:

“The filing deadline to submit 2021 tax returns or an extension to file and pay tax owed is Monday, April 18, 2022, for most taxpayers. By law, Washington, D.C., holidays impact tax deadlines for everyone in the same way federal holidays do. The due date is April 18, instead of April 15, because of the Emancipation Day holiday in the District of Columbia for everyone except taxpayers who live in Maine or Massachusetts. Taxpayers in Maine or Massachusetts have until April 19, 2022, to file their returns due to the Patriots’ Day holiday in those states. Taxpayers requesting an extension will have until Monday, October 17, 2022, to file.”

I think I’ve made my point; the IRS talks in ways that are clear as mud to most people. Don’t stop reading!  That’s the last paragraph I’ll quote from the IRS in this article.  Promise.

Seek to Understand Federal Taxes – Then Plan

Broken into pieces, though, the main aspects of our tax system are understandable, and with understanding comes the ability for better tax planning.  When you complete your federal tax return or you meet with your tax preparer to sign your forms, work to understand your average tax rate and your marginal tax rate.  They are very different and you may be surprised to learn you aren’t paying as large a percentage of your overall income to the IRS as you think.  I’m going to walk you through understanding what your average tax rate and marginal tax rate really mean. 

Your First Dollars of Personal Income are Not Taxed

You didn’t read that header wrong. Your first dollars of personal income are not taxed. Surprised?  

If a household doesn’t itemize expenses (and the majority don’t anymore), there is a standard deduction (outlined in the chart below). Your income up to the deduction you qualify for is not taxed. That means no Federal income tax is due on this amount.  You can use your 2021 tax return (the one being prepared now) for 2021 figures.  

For this discussion, however, let’s plan ahead for 2022 taxes (the return you will file early in 2023).

2022 Standard Deduction

Filing StatusDeduction amount
Married filing jointly$25,900
Head of household$19,400

Source: Internal Revenue Service

Many additional adjustments can reduce taxable income, like having dependent children, being elderly, or blind as examples.  As part of your Federal tax returns, all of the income you made over the course of a year is calculated and then all deductions are taken from that number to eventually calculate a number that is called your taxable income.

Marginal tax rates

If this is the first time you’ve had marginal tax brackets explained, you are not alone.  I have had attorneys, doctors, surgeons, and University professors, for example, take my courses and express this is the first time they have clearly understood tax brackets and marginal tax rates. 

The United States tax system has a progressive tax system.  People that have lower taxable income pay a lower percentage of tax on their taxable income while people with higher taxable income pay higher rates.  Tax rates are organized into tax brackets that have a range of income in each bracket.

2022 Chart of Federal Income Tax Brackets

2022 Federal Income Tax Brackets
2022 Tax RateFor Single FilersFor Married Individuals Filing Joint ReturnsFor Heads of Households
10%$0 to $10,275$0 to $20,550$0 to $14,650
12%$10,275 to $41,775$20,550 to $83,550$14,650 to $55,900
22%$41,775 to $89,075$83,550 to $178,150$55,900 to $89,050
24%$89,075 to $170,050$178,150 to $340,100$89,050 to $170,050
32%$170,050 to $215,950$340,100 to $431,900$170,050 to $215,950
35%$215,950 to $539,900$431,900 to $647,850$215,950 to $539,900
37%$539,900 or more$647,850 or more$539,900 or more
Source: Internal Revenue Service

How not to read the table above

Let’s say that Pat is a single individual and has $75,000 in taxable income. Don’t just glance at the table and assume, for example, that Pat will pay 22% taxes on all taxable income.  If you do, you might assume Pat’s tax bill is $16,500.  That’s not correct.  

Here’s how to read the table

Interpret the table, instead, one line at a time. 

2022 Tax RateFor Single FilersCalculating Pat’s taxes one line at a timeAmount of tax
10%$0-$10,275.10*$10,275=$1,027.50$ 1,027.50
12%$10,275 – $41,775.12*$31,500=$3,780$ 3,780.00
22%$41,775 to $89.075.22*$33,225=$7,309.50$ 7,309.50
Total federal income tax for Pat$15,117.00

Said another way, Pat will pay 10% on the first $10,275 of taxable income.   That would be $1,027.50 tax on those dollars.

On the next taxable income between $10,275 and $41,775, Pat pays 12%.  That would be $3,780 tax on those dollars

On the next taxable income from $41,775 to $75,000 Pat pays 22%.  The tax on that amount would be $7,309.50.

Finally, add the three tax amounts for a total of $15,117.

Pat’s marginal tax rate is 22%, because that is the tax bracket her last dollar of income was taxed at, not because she paid 22% on all of her taxable income.  For every additional dollar of taxable income Pat gets, up to a total of $$89,075 Pat will pay 22% income tax.  

If the individual has additional taxable income beyond $89,075, those dollars beyond $89,075 will be in a higher tax bracket and Pat will pay a greater marginal tax rate on the dollars beyond $89,075.

A Second Fact about Your Taxes to Know – Your Average Tax Rate

Your average federal tax rate can be useful in monthly and yearly tax planning.  It is particularly important to self-employed and retirees that need to have a clear understanding of what they will likely owe for federal income taxes.

Let’s go back to our example and calculate Pat’s average federal income tax rate.  Notice I was careful to talk about Pat’s taxable income so far.  That’s because Pat doesn’t have to pay income taxes on all income.  

In 2022, Pat’s standard deduction is $12,950.  Assuming Pat doesn’t itemize (and very few people do these days) and Pat has no other adjustments to income, Pat’s gross income is $87,950 ($75000 taxable income +$12,950 standard deduction.) $15,117 divided by $87,950 tells us his average federal tax rate is 17%. So on average, Pat pays 17% of each dollar earned in federal income tax. 

Now That You Understand the Chart, Consider your Average and Marginal Tax Rates

As we are in the middle of tax season, your tax return for this tax season may not be prepared at this time. If not, pull out your last year’s tax returns or estimate your taxable income for this year based on your understanding of your income. If you are uncertain, ask your tax professional. Review what your marginal tax rate is and what your average tax rate is. You may be surprised your average tax paid isn’t as high as you think. 

Why is knowing about marginal tax brackets important?

This information is important because once you know your marginal and average tax rates, you can work with your financial professionals to try to figure out how to claim exemptions or deductions that can lower your tax liability. You can make more informed financial decisions like if investing in a Roth or a Traditional IRA is more beneficial for you, and so much more.

Did You Like this Article on the difference between Marginal and Average Tax Rates

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