• MoneyVerbs Team

What are Tax Brackets and Why Should We Understand Them?

Okay, so what does J. Cole mean when he raps about “brackets?”

He’s talking about tax brackets in the United States tax system; who would have known.

In the US, we have what’s called a “progressive tax” system on earned income. This means that every wage earner falls into a certain tax bracket and is taxed at a certain percentage. Someone making $9,000 would fall into the 10% tax bracket, while a couple making $200,000 would fall into the 24%, married tax bracket.

Within the progressive tax system, there’s an additional breakdown between effective and marginal tax rates. Individuals in the lowest tax bracket (10%) pay 10%. Individuals in the next bracket pay 10% on the first $9,700 they make (for single income), then 12% on the next $29,775, and so on.

Re-read that last part again if you need to, but here is a helpful visual!

When you understand how taxes are charged, you can learn how to optimize for them. For example, if you save a portion of your money into a pre-tax 401(k) or IRA, you could drop your taxable income into a lower tax bracket. This can save you money now and allow future funds to grow – win/win!

Now, of course, income taxes aren’t the only kinds of taxes in our tax system. Many states charge residents taxes. If you own a home orland, you will probably pay property taxes as well. Other types of taxes include sales tax (taxes on purchases), sin tax (taxes on alcohol, cigarettes, or marijuana), and estate taxes (taxes on your assets).

Taxes aren’t fun, but they do have a place in our society. Some might debate their virtue, but our current tax system dictates how we pay them. 

Once you understand taxes, they don’t have to be so scary!

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