A taxpayer's tax bracket is simply the tax rate
schedule that a taxpayer falls under corresponding for their taxable income.
A tax bracket will always be greater than a taxpayer's
effective tax rate
because various
above-the-line deductions and
below-the-line deductions are subtracted from the taxpayer's
gross income, thus
reducing his or her
taxable income. Again, it is taxable income that matters in the
tax rate schedules (shown below) which determine a taxpayer's
tax liability.
Another reason the effective tax rate is always
lower than the rate associated with a tax bracket is that tax brackets are
progressive (the rate increases as taxable income increases). That means
the income that a taxpayer earned was affected by all of the tax brackets below
the highest one they enter. Imagine a taxpayer is in the 28% tax bracket.
They are affected by the 10%, 15%, 25%, and 28% tax bracket. An example of
this is shown below.
Tax brackets are often misunderstood by flight
crewmember's because many believe that the instant their taxable income enters a
higher tax bracket, that all of their taxable income is affected by the new tax
bracket. THIS IS NOT TRUE. Only the amount that is over and
above the threshold for a particular tax bracket is affected by the rate
associated with that tax bracket.
Example: Assume Beth is an airline pilot
that has a gross income of $115,000 in 2008. After she takes various
deductions, Beth's taxable income is reduced to $93,400. Assume Beth is
single in 2008. That would put Beth in
the 28% tax bracket because her income was between $78,850 and $164,550. Does that mean that
Beth's entire taxable income is
multiplied by 28%? No. Only the portion of her income that enters
the 28% tax bracket is actually multiplied by 28%. The remainder is multiplied by
the multipliers of lower tax brackets. The Add Column in the tax
rate schedules below is the tax liability sum of all of the tax brackets below
the current one, so to calculate Beth's tax liability, it would simply be:
$16,056.25 + [($93,400 - $78,850) x 28%] = $20,130.25
In this
example, her effective tax rate is $20,130.25 / $115,000 = 17.5%, which is obviously significantly less
than her tax bracket.
