Tax bracket, tax rate, what’s the difference?

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The difference between your tax bracket and your tax rate is more than a trick question. For example, knowing your tax rate gives you an accurate reflection of your tax liability in relation to your total income. Knowing your tax bracket is useful for planning purposes. For instance, you may want to spread a Roth conversion over several years in order to stay within the income limits of a particular tax bracket.

So, what’s the difference between the two? The main difference is that a tax bracket is a range of income to which a specific tax rate applies, while your effective tax rate is the percentage of your income that you actually pay in tax. Put another way, not every dollar is taxed at the same rate. Your tax bracket shows the rate of tax on the last dollar you made during the tax year. Your effective tax rate reflects the actual amount you paid on all your taxable income.

I find people often incorrectly think that once their income pushes them into a new tax bracket that ALL of their income is taxed at that rate. That is not the case. Every bracket of income keeps its tax rate. The first amounts of income in the 10% bracket will always stay taxed at 10% regardless of whether or not you are in the 25, 28 or 33% “bracket”. Only the amount of income that fall into the new, higher bracket are taxed at that rate. Every other bracket keeps its tax rate. So your tax rate is a blended rate of every bracket that you have income in. Someone may be in the 3% bracket, but their blended tax rate will be more like 27% because each bracket taxes income separately.

Keep that in mind when your income increases or you are do some tax planning. Tax rates and Tax Brackets refer to different calculations.

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