Marginal tax brackets are a frequently misunderstood topic. It’s not uncommon for someone to say they don’t want to get a raise because it will put them in a higher tax bracket and force them to pay more taxes on all the money they earn. They believe they would be better off not receiving the raise in the first place. This is a common misconception, but thankfully, that is not how marginal tax rates work.
For example, let’s say you receive a salary increase that takes your final salary from the 12% tax bracket to the 22% tax bracket. Your raise doesn’t place all of your income to the 22% tax bracket. You only pay the higher taxes on the amount that falls within the 22% tax bracket.
We’ll show you the income levels for each tax bracket and show some examples of income tax brackets and how marginal taxes actually work. You can use these to calculate your effective tax bracket or the amount of taxes you are actually paying on all of your income.
Understanding Marginal Tax Rates
Tax planning is one of the most fundamental aspects of financial planning. In fact, many people would argue that financial planning without respect to taxes is not really financial planning. Yet, in order to fully understand how tax planning works, it’s important to understand what your marginal tax rate is.
This “gradual” tax schedule is called a marginal tax rate system. In effect, the amount of taxes you pay increases as your income increases. The IRS places the marginal tax rates into brackets, making the marginal tax formula easier to understand and compute by hand. Let’s look at the 2019 Federal Tax Brackets to see this in action.
What Are Tax Brackets?
Before we can discuss marginal tax rates, it’s important to understand how income tax brackets work. For federal tax purposes (and most states that do not have a flat income tax), income tax brackets state the amount of tax that is paid for income earned within that bracket.
For example, in 2019, a married couple (filing jointly) making under 19,400 is taxed at 10% of their income. Thus, they’re in the 10% tax bracket. Once they make over $19,400, they are taxed at 12% of the income above $19,400. Now, they’re in the 12% tax bracket and will be until they earn over $78,950. Then, they’ll move up to the 22% tax bracket, where they’ll pay 22% on the income above $78,950, and so on.
Once you determine what income tax bracket you’re in, then your marginal tax rate is simply the applicable tax on your next dollar of earned income. For example, if you’re in the 22% tax bracket, then your marginal tax rate is 22%. For every additional dollar you earn, you’ll pay an additional 22 cents in tax. Conversely, for each dollar of decreased taxable income, you’ll save 22 cents in tax. It’s this understanding that helps define a sound tax planning approach.
What Does the Marginal Tax Rate Mean?
Now that we know what the marginal tax rate is, we can think about how it applies in tax planning. Simply put, every decision that has a tax impact can now be evaluated to determine the tax savings, and the after-tax financial impact. Decisions that might be very tax-wise in one tax bracket (such as accelerating or postponing taxable income) might not be prudent in another.
For example, let’s assume that you just bought a stock six months ago. Since then, a series of developments and bad earnings reports have convinced you to sell. Now, you’re trying to decide whether to sell the stock at the end of the year or at the beginning of next year. If you’re in the 12% tax bracket, but expect to be in a higher tax bracket next year, you might want to sell now. If you’re in the 32% tax bracket, but expect to be in a lower bracket next year, you might want to wait.
This is a basic example of how marginal tax bracket affects tax planning. We’ll look at another example in more depth. First, let’s discuss how you can find your marginal tax rate.
How Do I Find My Marginal Tax Rate?
To find your previous year’s marginal tax rate, you only need your tax return (Form 1040 for most people). Depending on the type of return, you’ll use the line that correlates to taxable income:
- Form 1040: Line 43
- Form 1040A: Line 27
- Form 1040EZ: Line 6
Once you determine your taxable income, you can refer to the IRS tax tables to figure your marginal tax bracket. Keep in mind your filing status (single, married filing jointly, married filing separately, or head of household), particularly if your status has changed. Since the IRS tax tables are updated as part of a revenue procedure that contains a lot of other annual updates, they can be cumbersome. You may find a plethora of websites, such as taxfoundation.org that make this information easier to digest.
2019 Federal Tax Rates, Standard Deductions, & Capital Gains
Here are the current tax rates. You can use this information to help plan your tax bill this year, as well as for long-term tax planning, such as doing a Roth IRA conversion, selling stocks for short-term or long-term capital gains, making charitable donations, and other moves that will impact your tax return.
2019 Federal Income Tax Brackets
|2019 Marginal |
|Single||Married Filing Jointly or |
|Head of |
|Married Filing |
|10%||$0 - |
|$0 - |
|$0 - |
|$0 - |
|12%||$9,701 - |
|$19,401 - |
|$13,851 - |
|$9,701 - |
|22%||$39,476 - |
|$78,951 - |
|$52,851 - |
|$39,476 - |
|24%||$84,201 - |
|$168,401 - |
|$84,201 - |
|$84,201 - |
|32%||$160,726 - |
|$321,451 - |
|$160,701 - |
|$160,726 - |
|35%||$204,101 - |
|$408,201 - |
|$204,101 - |
|$204,101 - |
2019 Standard Deductions
The Standard Deduction is an amount taxpayers can deduct from their income before paying income tax. You can choose to apply the Standard Deduction or itemize deductions, whichever results in the best tax return for your situation.
The Tax Cuts and Jobs Act substantially increased the Standard Deduction, removed personal exemptions, and decreased the amount taxpayers could deduct for SALT taxes (State and Local taxes, including state and property taxes). These tax changes make it less viable for many people to claim deductions.
Here are the current Standard Deductions:
|Filing Status||Standard Deduction|
Tax Year - 2019
|Married Filing Jointly||$24,400|
|Head of Household||$18,350|
It only makes sense to itemize tax deductions if they will be larger than the Standard Deduction.
2019 Long-Term Capital Gains Tax Rates
Capital gains taxes are assessed when you sell certain property or investments for a profit. Short-term gains are for investments you held for less than a year. These are assessed as regular income and are taxed at your marginal income tax bracket.
Long-term capital gains are for investments that were held for longer than a year. They are taxed at the following schedule:
|2019 Long-Term Capital |
Gains Tax Rate
|Single Filers |
|Married Filing |
|Head of |
|20%||Over $434,550||Over $488,850||Over $461,700|
Some investments, such as gold or collectibles, are not taxed by the capital gains guidelines.
Applying Federal Tax Rates to Your Situation
As you can see from the above federal tax bracket table, there are tax brackets for income ranges. For example, a married couple will pay the following taxes:
- 10% federal income tax on the first $19,400 of income;
- 12% federal income tax on income from $19,401 – $78,950;
- 22% federal income tax on income from $78,951 – $168,400;
- and so on.
As mentioned above, this is a gradual tax system. This does not mean that you will pay the corresponding income tax rate if you break the threshold by $1. For example, receiving a raise from $78,950 to $78,951 will not subject all of your income to the 22% tax bracket – it will only apply to income earned within that specific tax bracket. These gradual tax rates add up to your effective tax rate.
How to Your Calculate Effective Tax Rate
Let’s use an example of a married couple filing jointly with $100,000 of taxable income (after deductions, exemptions, etc.). They are in the 22% tax bracket but don’t actually pay $22,000 in federal taxes. They would pay:
- 10% on first $19,400 of income ($1,940)
- 12% on income from $19,401 – $78,950 ($7,146.00)
- 22% on income from $78,950 – $153,100 ($4,631.00)
- for a total of $13,717.00
In this example, the weighted, or effective tax bracket, is 13.717%.
Note: this is a very simplified example, and does not include any deductions. This example also only takes federal taxes into account and does not include state or local taxes. You should be able to find a state tax calculator to assist your calculations.
This is easy to figure out when you file your taxes, and most tax software programs, including TurboTax and H&R Block (H&R Block Online Review), can give you these calculations when you use their program.
Using Marginal Tax Rates for Tax Planning
Using your knowledge of the marginal tax rate system, you can use them to help reduce your taxes if you are near one of the tax bracket limits. All you need to do is bring your final number below the tax bracket.
For example, if you are married filing jointly and earn $80,950, you can contribute $2,000 to your 401k and avoid paying the higher tax rate on $2,000.
The marginal tax bracket on the amount over $78,950 would be 22%. By dropping back down to the 12% tax bracket, you can save 10% on the taxes paid for that $2,000. So your 401k contributions in this situation would save you $200 in taxes.
Again, this is a simplified example.
However, you can see that the tax savings can easily add up to a couple of hundred dollars to several thousand, depending on how much you can shave from your marginal tax rate.
Marginal Tax Rate Case Study
Let’s consider a young couple that is looking into converting their traditional IRA to a Roth IRA. To summarize, a Roth conversion is simply transferring funds from a traditional or non-deductible account to a Roth account. The benefit is that you do not pay taxes on earnings in a Roth account.
However, you have to pay taxes on any traditional IRA funds that you convert. It makes sense to do this if you expect to be in a higher tax bracket in your retirement years when you are drawing from your IRA.
Joe & Jane have a traditional IRA account valued at $50,000. They’ve been saving diligently since they got married 5 years ago. They feel like they’re doing pretty well, especially since they’re only 30. At some point, they heard that a Roth IRA would be better suited for their financial goals, especially if they can convert at a relatively low tax rate. In order to do so, they have to pay ordinary taxes on the converted amount.
Let’s calculate their tax bracket. Since Joe is an O-3 in the Air Force, and has been in for 8 years, their monthly income is $6,241.57. Assuming they have no other taxable income, this puts their 2019 annual taxable income at $74,899.00 (rounded up to the nearest dollar). Exemptions and deductions notwithstanding, this puts them squarely in the 12% tax bracket. This is their marginal tax rate.
Let’s assume that Joe & Jane want to convert as much as they can, but stay within their current tax bracket. A quick look at the tax tables shows that they’ll remain in the 12% bracket until their income reaches $78,950. In other words, they could convert $4,051 this year at 12%. After that, they would pay 22% for the amount above $4,051.
Without going into detail about what Joe & Jane SHOULD do, let’s talk about what they COULD do:
- They could convert the entire amount this year. They would pay a total of $10,594.90. This includes $486.12 for converting $4,051 at the 12% rate plus $10,108.78 for converting the remaining amount at the 22% rate.
- They could convert up to the 12% limit without going over. In doing so, they would pay $486.12 this year. They could always revisit this in future years to take advantage of their 12% tax bracket. Assuming they could fully convert at the 12% bracket, they would pay a total of $6,000. This would save them over $4,500 compared to converting their entire IRA at one time…with no substantial impact to their portfolio! Remember, we’re not talking about changing investments, we’re only talking about changing asset location from a tax-deferred to a Roth account.
- They could choose not to convert at this time. They could make this decision based upon any number of reasons. Perhaps they find a better opportunity. Maybe the tax rules change. Perhaps there’s an upcoming deployment that allows them to convert some of their money at the 10% bracket.
Again, we’re looking at rough assumptions to show how tax brackets work, and factors to consider for tax planning purposes. In the above case study, we are assuming there are no additional deductions that reduce taxable income. Contributing to a Traditional IRA, the Thrift Savings Plan (similar to a government 401k), or itemizing deductions can reduce the taxable, which means the individual may be able to convert more money within the 12% tax bracket.
Understanding Marginal Tax Brackets is Essential for Tax Planning
That’s an example of how understanding your marginal tax bracket influences your tax planning. It’s important to highlight that tax should be a consideration, but not the only consideration. Bad investments do not become sound ones because they’re tax-efficient. Bad purchases (such as buying more of a house than you need or can afford) do not become good ones just because there’s a tax benefit.
However, tax efficiency can make a good investment even more compelling, or it could make an otherwise ho-hum investment a better one. More importantly, it can help you think in more than one dimension. Instead of focusing on ‘either-or,’ tax-planning also should include ‘when?’
In Joe & Jane’s example, you can understand their approach if they decide to stretch out their Roth conversions over a 10-15 year period. Since they’re only 30, there is zero impact on their ability to use the money in retirement. However, that extra $4,500 could grow into much more over time. Of course, this could not happen if Joe & Jane didn’t take the time to understand their marginal tax rate or what tax bracket they’re in. Without understanding your marginal tax bracket, tax planning cannot take place.
There can be many opportunities to incorporate tax planning into your financial planning. Understanding your marginal tax bracket is the first step in being able to determine what tax planning decisions are best for your situation. While this article is not a substitute for tax advice, I hope it helps set an educational foundation for future planning efforts.