Legal Definitions - tax bracket

A tax bracket refers to a specific range of taxable income that is subject to a particular tax rate. In a progressive tax system, like the one used by the U.S. federal government and many states, different portions of a person's income are taxed at increasing rates as their total income grows. This means that income up to a certain amount is taxed at one rate, the next portion of income is taxed at a higher rate, and so on.

It is crucial to understand that the tax rate for a specific bracket only applies to the income that falls within that particular range, not to a person's entire income. For example, if someone's income spans three tax brackets, the lowest portion of their income is taxed at the lowest rate, the middle portion at a higher rate, and the highest portion at the highest applicable rate.

• Example 1: A Recent Graduate's First Salary

  Imagine Liam, a recent college graduate, secures his first full-time job with an annual salary of $48,000. For illustrative purposes, let's assume a simplified tax structure where income up to $18,000 is taxed at 10%, and income between $18,001 and $55,000 is taxed at 15%.

  How it illustrates the term: Liam's first $18,000 of income would fall into the 10% tax bracket. The remaining $30,000 of his salary ($48,000 - $18,000) would then fall into the next tax bracket, being taxed at 15%. This demonstrates that his entire $48,000 is not taxed at a single rate; instead, different segments of his income are taxed according to the specific bracket they occupy.

• Example 2: A Freelancer's Unexpected Project

  Consider Maria, a freelance graphic designer who typically earns around $70,000 per year. She unexpectedly lands a large, lucrative project that brings in an additional $25,000, increasing her total income for the year to $95,000. Let's assume her income typically spans brackets up to 20%, and the next bracket is 25% for income over $85,000.

  How it illustrates the term: Maria's initial $70,000 income would have been taxed across several lower brackets. When she earns the additional $25,000, the first $15,000 of that bonus ($85,000 - $70,000) would be taxed at her current highest bracket rate (e.g., 20%). However, the remaining $10,000 of her bonus ($95,000 - $85,000) would push her into the next, higher tax bracket and be taxed at 25%. This shows how additional income is taxed at the rate of the highest bracket it falls into, rather than her entire income being re-taxed at a new, higher average rate.

• Example 3: A Retiree with Multiple Income Streams

  Arthur is a retiree whose annual income totals $32,000, derived from a combination of Social Security benefits, a small company pension, and dividends from his investments. For simplicity, assume income up to $12,000 is taxed at 8%, and income between $12,001 and $40,000 is taxed at 12%.

  How it illustrates the term: Despite having multiple sources, Arthur's total taxable income of $32,000 is subject to the progressive tax bracket system. His first $12,000 of income would be taxed at 8%. The subsequent $20,000 ($32,000 - $12,000) would then fall into the next tax bracket and be taxed at 12%. This demonstrates how the concept of tax brackets applies to the cumulative taxable income, ensuring that lower income portions are taxed at lower rates, regardless of where the income originates.