That’s a question one of my clients asked recently as we prepared for 2008 taxes. I’m sure it’s a question a lot of you have so here’s an example and my explanation.

You can see that the marginal tax bracket is higher than the actual percentage of gross income paid to taxes. That’s because the government taxes the first money you make at a lesser rate than the later money and what that means is that the more you make, the more you pay in taxes.

But, if you are in the 33% tax bracket, it doesn’t mean that you pay 33% of your income in taxes. It does mean that each additional dollar you make over a certain threshold (that changes each year) is taxed at 33% while lower amounts are still taxed at lower percentage rates. 

For a single person in 2008, taxable income (after deductions and the personal exemption) between $0 and $8,025 is taxed at 10% and income between $8,026 and $32,550 is taxed at 15%. If you had $32,551 ($1 more) in taxable income, that extra dollar would be in the 25% bracket and you’d pay an additional 25 cents in federal income tax but the lower amounts are unaffected. That’s why people look for additional deductions (retirement, charitable contributions, medical, etc.) when they move up to the next bracket. 

This taxable income (estimated, of course) is at or below the $32,550 so you are in the 15% marginal tax bracket.

There’s still time in December to see your tax professional and to increase your deductions if it will reduce your taxable income and your taxes. The best ways to reduce your taxable income is through charitable contributions, medical expenses (check with your preparer on this one – it’s tricky) and retirement contributions. 

This is an example and is not a guarantee of your tax bill. Please check with your personal tax preparer.

Please feel free to comment below.