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Tax Bracket

What is a tax bracket?

A taxpayer's tax bracket is simply the tax rate schedule that a taxpayer falls under corresponding to 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 that determine a taxpayer's tax liability.

Why is my effective tax rate lower than my tax bracket (marginal tax rate)?

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 hypothetical tax system that has 10%, 20%, 30%, 40%, and 50% tax brackets.  Assume a high-income taxpayer is in the 50% tax bracket.  Their entire income is NOT taxed at 50%.  Only the amount that exceeds whatever the threshold is set by the IRS for the 50% tax bracket.  The income below this threshold is taxed at the respective 10%, 20%, 30%, and 40% tax brackets.

How do tax brackets affect a pilot or flight attendant's per diem deduction?

One interesting insight about tax brackets is that while the higher tax brackets pay the highest taxes, they also benefit the most from tax deductions.  Assume two fictitious taxpayers have $10,000 to write off for a tax deductible widget they purchased.  Assume taxpayer 1 is in the 10% tax bracket and taxpayer 2 is in the 50% tax bracket.  The taxes saved for taxpayer 1 will be $10,000 x 10% or $1,000 while the taxes saved for taxpayer 2 will be $10,000 x 50% or $5,000.

Note that if a taxpayer is affected by the AMT, the normal tax brackets disappear and the taxpayer is subject to a different tax system.  The AMT happens when a taxpayer has a high gross income and a lot of tax deductions.  The IRS forces these taxpayers to check and see if they are required to pay the AMT tax.

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