Everybody pays income tax, but the rate of taxation depends on how much money you make each year. The tax is applied through a tier system: your entire income is taxed at different rates as it exceeds the limits of the previous brackets. Are you confused yet? There’s no need.
What are tax brackets and how do they work?
Every year, the IRS releases the federal income tax brackets. Tax brackets are not your actual income tax rate; they are levels of income that determine your income tax. Depending on how you file your taxes, you may follow a separate set of tax brackets. Let’s say you’re single with no dependents, and you make $9,000 in taxable income a year. That would place you in the lowest level of tax brackets; as of 2015, people with incomes ranging from $0 to $9,225 would pay 10% of their taxable income in taxes.
On the other hand, your older sister Sarah is making $25,000 a year. She’s single and has no dependents, so she follows the same bracket standards as you do. However, her higher income places her in the next tax bracket just above yours, which ranges from $9,226 to $37,450. Your sister will pay $922.50 in income tax—she pays the same 10% tax rate on her income up to the $9,225 limit of the first bracket. Her income that exceeds the $9,225 limit (the remaining $15,775) is taxed 15%.
What if I'm married?
The previous examples used the brackets for single people with no dependents. The limits for married couples filing jointly, qualifying widow(er)s, and people filing as the head of the household are higher than the single standard of $9,225. Instead, the limit at the lowest bracket is $18,450. Married couples who file separately have the same limitations as single individuals.
Why are tax brackets important?
The revenue from these taxes goes towards public services that everyone uses and benefits from. Alternatives to this tiered tax system, such as a fixed percentage tax for all, would burden people with lower incomes. Tax brackets distribute the responsibility fairly. Although the wealthy are taxed more, they can afford to pay more in taxes.
You’ve probably heard about how desirable the top tax bracket is, but in reality, many people belong to more than one tax bracket and have the portions of their income in lower brackets taxed at the appropriate rate. And every year, the IRS releases a new set of tax brackets. The taxation rates stay the same—only the income limits between the levels changes. In 2014, the range for the first tax bracket was $9,025. This year, it has increased by $200.