Income taxation in the United States is done by assigning different tax rates to each specific range of income.
Generally the lower income amounts will correspond to lower percentage toward federal income tax than higher income amounts. This is called a progressive tax and is frequently misunderstood.
Many people mistakenly think that if they “fall into” a specific tax bracket based on their income that they will owe that higher tax rate that corresponds to the bracket on all of their income.
This is actually not true.
When you look at tables for income tax brackets, you will see that different levels of income are assigned a specific rate of taxation.
What is not as obvious is that everyone will owe those various rates only on the amount of their income that falls within each range; a wealthy person earning enough to be “in” the highest tax bracket will pay all of the lesser tax rates on the amounts of his or her income that fall within each bracket.
The idea is that everyone needs more of their base income that covers their cost of living; the government would be wrong to tax it.
But the taxes get progressively higher for the money that is not as urgently needed — the highest tax rates will only apply to what some refer to as the “last dollar earned,” meaning only the top layer of the layer cake will have such a large percentage of it taken by Uncle Sam.
When you add up all the taxes paid on the various bands of your income, and divide it by your total income, you will see your Effective Tax Rate (basically), which will be less than your “last dollar” rate because it’s a weighted average of the tax rates you paid.
Some very high-income people will have such a large proportion of their income taxed at the highest rate that it is as if it were all taxed that way; the first few $100,000 of so of their income is a relatively small percentage of their total income.
Are Social Security Benefits Taxed?
What is a Foreign Tax Deduction?
What is Federal Income Tax?