For instance, you may want to spread a Roth conversion over several years in order to stay within the income limits of a particular tax bracket.
So, what's the difference
between the two? The main difference is that a tax bracket is a range of income
to which a specific tax rate applies, while your effective tax rate is the
percentage of your income that you actually pay in tax. Put another way, not
every dollar is taxed at the same rate. Your tax bracket shows the rate of tax
on the last dollar you made during the tax year. Your effective tax rate
reflects the actual amount you paid on all your taxable income.
For example, say you're single
and in the 25% bracket for 2016. That means your taxable income is between
$37,650 and $91,150.
Yet the tax you pay is less
than 25% of your income.
Why? Because the 25% tax rate
only applies to the amount of taxable income within the 25% bracket. The tax on
income below $37,650 is calculated using the rate that applies to income in the
10% and 15% brackets.
So, if your 2016 taxable income
is $40,000, only $2,350 is taxed at 25%. The remainder is taxed at 10% and 15%,
leading to a "blended" overall rate. The result: a tax bracket of
25%, and an effective tax rate of less than that.
Good tax advice can affect both
your bracket and your rate. Want to know how? Contact us at (518) 798-3330.
