Do you know your income tax bracket? I know ours. For 2013, we were in the 25% federal tax bracket. But what does that really mean?
For background, since I’m married and we file jointly, that means our taxable income fell somewhere in the $72,501-$146,400 range.
If you want to narrow things down a but further, our income fell north of the so-called Social Security wage base, or the income ceiling on which FICA-OASDI taxes are levied. That’s $113,700 for 2013.
This comes after having reduced our taxable income by deferring a substantial chunk via multiple retirement plans, as well as holding tax-exempt bonds on the taxable side of our portfolio, etc. But that 25% tax bracket only tells part of the story.
As I’ve mentioned in the past, tax brackets reflect marginal rates. You only pay that percent on the last dollars that you earn. Taxes on your earlier dollars (i.e., those that fill the lower brackets) are at a lower rate, and investment income is also often taxed at favorable rates.
So, to arrive at your effective tax rate, you divide your total taxes paid (line 61 of Form 1040) by your total taxable income (line 43 of Form 1040) and multiple by 100. In our case, this worked out to an effective federal income tax rate of 15.2%, considerably lower than our marginal rate of 25%.
On the state side, the difference was much smaller. We’re in the 6% state income tax bracket and paid an effective rate of 5.8% of our taxable income to the state. Why? Well, yes, we do have graduated tax brackets (1%-6%) but the lower brackets are very narrow so the majority of our income is taxed at the top rate.
What about you? Which tax bracket are you in? And what was your effective rate?