I’ve received lots of letters and e-mails from people who are confused about how to determine what their income tax bracket is. They are understandably confused; for 2005, there are six brackets: 10 percent, 15 percent, 25 percent, 28 percent, 33 percent and 35 percent. Moreover, the brackets are indexed, or adjusted annually to account for inflation. Indexing is supposed to provide relief from bracket creep, which enriches Uncle Sam at the expense of individuals who get pushed into higher brackets even though their incomes merely stay even with inflation, and whose actual, after-tax incomes are, therefore, eroded.
The 10 percent bracket applies to taxable income of up to $7,300 for singles and $14,600 for married couples filing jointly. Taxable income (line 42 of Form 1040 for 2004) is what is left after wages and other kinds of reportable income are offset by all allowable deductions and before any credits are claimed. The next three brackets are: 15 percent (income between $7,300 and $29,700 for singles and between $14,600 and $59,400 for joint filers); 25 percent (income between $29,700 and $71,950 for singles and $59,400 and $119,950 for joint filers); and 28 percent (income between $71,950 and $150,150 for singles and $119,950 and $182,800 for joint filers). Only when income surpasses $150,150 for singles and $182,800 for joint filers does the 33 percent bracket kick in. Finally, there is the 35 percent bracket on incomes above $326,450 for singles and joint filers.
Working Out Your Top Bracket
Let’s look at joint filers Brian and Patricia Hickey. They declare a gross income of $95,000 solely from wages. For the sake of simplicity, let’s assume they received no other income taxed at reduced rates, such as dividends and long-term capital gains. Their personal exemptions and itemized deductions come to $25,000, leaving them with taxable income of $70,000. So their top federal tax bracket is 25 percent. Their being in the 25 percent bracket does not mean that the IRS exacts 25 cents from every dollar of income the Hickeys declare, contrary to what many people mistakenly believe. Just the dollars that fall in the 25 percent bracket are taxed at that rate. The part of their income that falls into the 10 percent and 15 percent brackets—the first $59,400—is taxed at 10 percent on the first $14,600 and 15 percent on the income between $14,600 and $59,400. Only the part between $59,400 and $70,000 is taxed at 25 percent.
The couple’s taxable income can go as high as $119,950 before the Hickeys are bumped into the next bracket, where each added dollar of income is dunned at 28 percent. To ease themselves into the 15 percent bracket, their taxable income must drop below $59,400. The Hickeys need to crunch more numbers when they are liable for both federal and local taxes. Their combined top bracket is not the sum of their federal, state and city brackets. Rather, it is their top federal bracket, plus the state and city brackets, minus the federal tax savings that becomes available because they can claim the local taxes as itemized deductions on Form 1040’s Schedule A.
Let’s say they are in a 4 percent bracket for state taxes. To determine their top tax bracket, they multiply their 25 percent federal bracket by their state rate and subtract the result (1 percent) from their state rate. Then they add the result (3 percent) to their federally imposed rate to arrive at a combined rate of 28 percent.
Julian Block may be reached at firstname.lastname@example.org .