marginal tax rate

Example

“Although in the 24% marginal tax bracket, her effective tax rate was only 18% because lower income was taxed at lower rates.”

Memory Tip

MARGINAL rate = the rate on your LAST dollar earned. Not what you pay on all income.

Why It Matters

Understanding your marginal tax rate helps you make better financial decisions about earning extra income, taking deductions, or making investments. It shows you the actual percentage of additional income that goes to taxes, which is different from your overall effective tax rate and can significantly impact whether certain financial moves are worthwhile.

Common Misconception

Many people mistakenly believe that moving into a higher tax bracket means all their income gets taxed at that higher rate. In reality, only the income within that bracket is taxed at the marginal rate, while all previous income remains taxed at the lower rates of their respective brackets.

In Practice

If you are in the 24 percent federal tax bracket and earn an extra 5000 dollars from a side project, that additional 5000 dollars is taxed at 24 percent, meaning you owe 1200 dollars in federal taxes on it. However, your existing income that falls in lower brackets remains taxed at those lower rates, so your total tax burden does not jump to 24 percent on everything you earned.

Etymology

From Latin 'margo' (edge, border) — the rate applied at the MARGIN (edge) of your income.

Common Misspellings

Related Terms

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