The Comprehensive Guide to

Passive Income Investing

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What is a Tax Rate?

A tax rate is the percentage of income a person or company pays in taxes.

How Does a Tax Rate Work?

The United States has a progressive tax system, which means that different portions of a person's income are taxed at different rates (the rates are often referred to as 'marginal tax rates').

For example, the IRS might tax a single filer's $100,000 income as follows:

The first $8,025 is taxed at 10% = $802.50
The next $24,525 is taxed at 15% = $3,678.75
The next $49,100 is taxed at 25% = $12,275.00
The final $18,350 is taxed at 28% = $5,138
Total tax owed: $21,894.25

Because this filer's highest taxable rate is 28%, we say that he or she is in the 28% tax bracket. note, however, that not ALL of the taxpayer's income is taxed at 28%. In fact, the taxpayer's effective tax rate is $21,894.25 / $100,000 = 21.9%.

The highest tax brackets often change, but they are usually around 35%. Note that income tax rates exclude state taxes and social security/Medicare, which add as much as another 17%-18% in taxes.

Why Does a Tax Rate Matter?

It's important to know the difference between tax brackets and tax rates. Many people assume that when they're in the 28% tax bracket, for example, that all of their income is taxed at 28%, which is not the case. As our example shows, you can be in the 28% tax bracket but have a much lower effective tax rate on your income.

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Paul Tracy
Paul Tracy

Paul has been a respected figure in the financial markets for more than two decades. Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 3 million monthly readers.