Tuesday, January 20, 2009

What Are Tax Brackets? - Speak Out California Weblog

What Are Tax Brackets? - Speak Out California Weblog

A "progressive" tax is one where the tax rate increases as income increases. A progressive tax structure consists of brackets. You pay a certain tax rate on income up to the next bracket. After that bracket is reached, a higher tax rate applies to income that is earned that is above that amount. Let's say that you pay 5% on income below $10,000 and 7% on income above $10,000. So if you make exactly $10,000 of income the tax is $500. At $10,100 the tax is still that $500 on the amount below $10,000 and $7 on the additional $100, for a total of $507. The key point is that only the amount in the new bracket is taxed at the higher rate.

I thought I understood tax brackets but apparently I didn't.

Many people believe that once you reach a higher bracket you pay the higher tax rate on all the income that falls below that bracket amount as well. I have actually talked to people who think they need to "get their income into a lower bracket" to avoid paying a higher tax rate, because they think that a higher tax rate would apply to all of the income they earned.

I remember thinking the same thing. I think we get a lot of misconceptions about taxes from "common knowledge" passed on from our parents, friends and coworkers. We need to be more diligent as a country and not let this type of misconception propagate.

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