As the year comes to a close, and we get ready to move to a new year, you may hear lots of conversation regarding how to cut your taxes.  Articles and blogs will state various strategies that can be used and things can be easily become overly complicated.  One basic principle that surprisingly most people don’t understand is how the federal income tax brackets actually work.  In passing, I have heard people chat about maxing out retirement withdrawals but being careful not to get bumped up to the next tax bracket.   They fear that if they get into the next tax bracket, they will be doomed.  Although on the surface, this idea makes sense as tax rates rise based on total income, most do not realize that our federal tax brackets are based on marginal tax rates.  How exactly do marginal tax rates work? 

A marginal rate is what you pay on an additional dollar of income.  In essence, the first segment of your income is taxed at the lowest rate, then the next segment of your income is taxed at the next rate tier, and this continues until you reach the top end of your income for the year.   The easiest way to illustrate this is with an example:

2024 Federal Tax Brackets:

Tax Rate           Single                                         Married Filing Joint

12%                    $11,601 -$ 47,150                    $23,201 – $94,300

22%                    $47,151 – $100,525                 $94,301 – $201,050

24%                    $100,526 – $191,950               $201,051 – $383,900

32%                    $191,951 – $242,725               $383,901 – $487,450

35%                    $242,726 – $609,350               $487,451 – $731,200

37%                    $609,351 +                                    $731,201+

So, what would the taxes owed be for a couple filing joint with a total adjusted gross income of $225,000?   Many would guess the tax rate would be 24% of $225,000 but that is incorrect! 

The tax rate is a combination of the 12% (on the first $94,300), then 22% on the next $106,750 (difference between the top of income ranges: $201,050 – $94,300), and then the 24% rate only applies to the amount that exceeds the top of the range below it ($201,050).  So in this example, the 24% tax rate only applies to $23,950 and not the entire $225,000.

Taxable Income:  $225,000 for a married couple filing joint:

Tax Rate	Top of Range	Income to Tax	Taxes Owed
12%	$94,300	$94,300	$11,316
22%	$201,050	$106,750	$23,485
24%	$383,900	$23,950	$5,748
Totals		$225,000	$40,549

So, as you can see, if you decide to take a retirement plan withdrawal or have another situation that will cause your income to rise for 2024, you do not need to live in fear. Two things are certain in life “death and taxes” and we shouldn’t let the fear of being bumped to the next tax bracket scare us. Remember, you will only pay that higher tax rate on the portion of your income that exceeds the income level at the top of the tier below, not the entire amount. The best common sense advice is to carefully plan any retirement plan withdrawals and have taxes withheld or set aside on those amounts if they are coming from a traditional IRA, 401K, 403(b) or similar plan. If you play it safe and have a little extra withheld, you will not be in for any big surprises when you do your taxes.