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How Income Tax Brackets Work - Example
Apr. 25th, 2025 07:11 amTwo weeks ago I wrote about filing my taxes and remarked that my effective federal tax rate for 2024 was 19%. I noted that's a lot lower than many people think their taxes are— not because my rate is low, but because most people way overestimate their tax rate because they don't understand how income tax works. And I don't mean misunderstanding the intricacies of complex tax situations; I'm talking about completely failing to understand the basics of how tax brackets work. And that includes a lot of people I've met in school and through work—intelligent people, people who attended highly competitive schools, people who've earned STEM degrees, people who are professionally employed and well paid.
Let me illustrate this through an example or two. Let's say Alice earns a gross pay of $120,000 a year. That's reasonably good money, BTW. It's just over twice the 2024 US median individual income of $59,228 (per the Bureau of Labor Statistics).
So, what's Alice's tax rate? Well, let's start by looking at the tax brackets for 2024:
This table is straight from the IRS, at Federal income tax rates and brackets.
You might look at the table and say, "Ah, Alice's tax rate is 24%"— because her $120k/yr is in the 24% tax bracket. If that's your conclusion, you're wrong— twice.
Of course, it could be worse. You could be like a professional colleague, "Brian", who complained to me that his federal tax rate is 50%. He didn't even look at an actual chart like this; he just repeated a bullshit number from a political bellyacher who tells lies on his radio program/podcast every day. 🙄
Okay, but why is Alice's "I pay 24%" estimate wrong? Twice?
First, it's wrong because tax brackets are graduated. If you're "in" in the 24% bracket, you're not paying 24% on everything, just on the portion of your income over the threshold for the 24% bracket. Parts of your income are taxed at the lower bracket rates of 22%, 12%, and 10%.
Second, Alice doesn't actually pay 24% on anything— because she's not actually in the 24% bracket! That's because there's an effective bracket of zero percent that's not indicated in the table above. Pay careful attention that the table is indexing taxable income— and taxable is not the same as gross. Two common deductions ordinary taxpayers enjoy are the standard deduction and a 401(k) deduction. For 2024 the standard deduction was $14,600. And let's say Alice put a modest 6% of her gross income, or $7,200, into her 401(k). Together these reduce her taxable income to $98,200. Alice is in the 22% tax bracket!
Now that we have Alice's taxable income, $98,200, we can figure her tax. No, it's not $98,200 x 0.22 = $21,604. Remember, the rates are graduated. She pays 10% on the first $11,600 out of $98,200, 12% on the next $35,550, etc. Alice's tax bill on her $98,200 taxable income works out to $16,657.
Alice's tax bill is $16,657. On a gross income of $120k. Thus her overall federal income tax rate is 13.9%.
There are other taxes, of course. Assuming Alice's income is all from wages, it's subject to Social Security and Medicare taxes. Those would tally $9,180 in this example. Combining that with her federal income tax brings her total tax paid to Uncle Sam to 21.5%. But even that is less than half of Brian thinks she's paying.
Let me illustrate this through an example or two. Let's say Alice earns a gross pay of $120,000 a year. That's reasonably good money, BTW. It's just over twice the 2024 US median individual income of $59,228 (per the Bureau of Labor Statistics).
So, what's Alice's tax rate? Well, let's start by looking at the tax brackets for 2024:
This table is straight from the IRS, at Federal income tax rates and brackets.
You might look at the table and say, "Ah, Alice's tax rate is 24%"— because her $120k/yr is in the 24% tax bracket. If that's your conclusion, you're wrong— twice.
Of course, it could be worse. You could be like a professional colleague, "Brian", who complained to me that his federal tax rate is 50%. He didn't even look at an actual chart like this; he just repeated a bullshit number from a political bellyacher who tells lies on his radio program/podcast every day. 🙄
Okay, but why is Alice's "I pay 24%" estimate wrong? Twice?
First, it's wrong because tax brackets are graduated. If you're "in" in the 24% bracket, you're not paying 24% on everything, just on the portion of your income over the threshold for the 24% bracket. Parts of your income are taxed at the lower bracket rates of 22%, 12%, and 10%.
Second, Alice doesn't actually pay 24% on anything— because she's not actually in the 24% bracket! That's because there's an effective bracket of zero percent that's not indicated in the table above. Pay careful attention that the table is indexing taxable income— and taxable is not the same as gross. Two common deductions ordinary taxpayers enjoy are the standard deduction and a 401(k) deduction. For 2024 the standard deduction was $14,600. And let's say Alice put a modest 6% of her gross income, or $7,200, into her 401(k). Together these reduce her taxable income to $98,200. Alice is in the 22% tax bracket!
Now that we have Alice's taxable income, $98,200, we can figure her tax. No, it's not $98,200 x 0.22 = $21,604. Remember, the rates are graduated. She pays 10% on the first $11,600 out of $98,200, 12% on the next $35,550, etc. Alice's tax bill on her $98,200 taxable income works out to $16,657.
Alice's tax bill is $16,657. On a gross income of $120k. Thus her overall federal income tax rate is 13.9%.
There are other taxes, of course. Assuming Alice's income is all from wages, it's subject to Social Security and Medicare taxes. Those would tally $9,180 in this example. Combining that with her federal income tax brings her total tax paid to Uncle Sam to 21.5%. But even that is less than half of Brian thinks she's paying.
