Every year the IRS releases updates and makes minor changes to the federal income tax brackets and tax rates to adjust for inflation. New rates have been published for the 2023 tax year.
How Do Federal Income Taxes and Tax Brackets Work?Ordinary income tax rates are applied to the following types of income you may receive throughout the year:
– Wages
– Cash bonuses
– Short-term capital gains. Profits on investments held less than one year.
– Interest or coupon payments
These forms of income are taxed in the United States under a progressive tax system. This means the more you earn, the higher your tax rate.
Under a progressive tax system, your first dollar and your 50,000th dollar are taxed at different rates. The highest tax bracket you fall into is your marginal tax rate. “Marginal” refers to how much tax you pay on the next dollar you earn.
Marginal tax brackets are essential to understand for effective tax planning. Tax credits or deductions that lower your taxable income will reduce your taxes at the marginal tax rate.
Therefore, when you consider various tax-advantaged strategies, deductions, or retirement plans, such as Traditional vs Roth plans, your potential tax savings and decisions should be based on your marginal tax rate.