What is a Tax Bracket?

While some countries (primarily countries from the old Soviet Bloc) use a flat tax system, a majority of nations (including the US) use a graduated tax system. That means citizens who have lower incomes pay a smaller percentage of their income in taxes (i.e. - lower tax rate) and citizens with higher incomes pay a higher tax rate. The general reason behind this method of taxation is that those who have lower incomes need most of their income to provide for basic needs like food and housing while those with higher income can live off a smaller portion of their income. Whether you agree or disagree with the reasoning, your tax bill is largely determined by graduated tax brackets, which are really just ranges of taxable income. As your taxable income moves up this ladder, each layer gets taxed at progressively higher rates.

How do tax brackets work?

In 2023, a young single dentist with $185,000 in taxable income would be in the 24% tax bracket. This doesn’t mean all of their income is taxed at that rate because the first slice of taxable income is taxed at 10%, whether you are working a part-time job during dental school or running a successful practice with $1.5mil in profit. The next slice gets taxed at 12%, and so on. As shown above, only the portion of the dentist’s taxable income from $100,526 to $191,950 would be taxed at the 24% rate. This top rate for the last dollar of taxable income is referred to as the marginal rate.

What are the current tax brackets?

The tax code has seven income-tax brackets for individuals that range from 10% to 37%. The 10% rate takes effect at the first dollar of taxable income, after benefits such as the standard deduction are applied, and each tax rate applies to income in that bracket.

Are tax brackets adjusted for inflation?

The income-tax brackets are adjusted annually for inflation, although in 2017 Congress switched to a slower method of calculating it. Tax brackets can also be changed by Congressional law as they were in 2017 when they were lower to there current rate structure. These lower brackets are temporary and will expire after 2025 unless extended by Congress.

what is an effective tax rate?

The effective tax rate is much lower than that top/marginal rate as it is the average tax rate you paid on your total income. While we often encourage clients to optimize their marginal tax bracket with effective tax planning, the true goal is to maintain the lowest effective tax rate over a lifetime. That may mean paying more in one year if it will saves more in future years.

Since each taxpayer is different, each tax plan for optimization of the effective rate is different as well.

Any CPA should be able to reduce your annual marginal rate but if you are interest in reducing your lifetime effective rate, please schedule a consultation with JNG Advisors today.