Definition of Tax Brackets
There is nothing quite like the surprise of tax time: after a promotion and raise, it seems suddenly the taxman shows up demanding more money and a lot more than expected. This is why it is important to know and understand how your taxes are calculated and how tax brackets work.
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Calculating AGI
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Your actual taxable income is not the salary you earn or your hourly rate times how many hours you worked in a year. Instead, take the total amount you earned for the year. Subtract any pre-tax retirement contributions and other tax deductions you warrant. The difference or result is your adjusted gross income, also referred to as your AGI. Your AGI determines your tax bracket.
Tax Rates
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The IRS publishes a tax table every year. The chart shows the charged tax for each range of income. For example, according to the IRS' 2009 Tax Table for the 1040 Form, a married couple filing jointly with an AGI of $74,725, would pay $11,056 for the year. A single person with an AGI of $55,200 will pay $9,994. The chart follows income increments of $500 for easy assessment.
Marginal Rate
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According to CNN Money.com, when people ask "what's your tax bracket?" they are really asking "what is your marginal tax rate?" Taxes are calculated according to brackets. For the married couple filing jointly in 2009 with an AGI of $74,725, the IRS determined that every dollar earned up to $16,700 was taxed 10 percent, totaling $1,670. Every dollar earned from $16,700 to $67,900 was taxed 15 percent, adding another $7,680. Finally, every dollar earned from $67,901 to $74,725 was taxed 25 percent, adding yet another $1,706. The sum of the tax bracket totals equals $11,056, the same number given on the IRS' tax table, making this couple's tax bracket 25 percent.
Annual Changes
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Each year, tax rates and exemptions change according to the laws passed by Congress. For example, the IRS increased the standard deduction for both for singles and married individuals filing separately by $250, as well as married couples filing jointly by $500. In fact, the tax brackets changed in 2009 in the taxpayers favor. This means that if your AGI were the same as the year before, you would actually pay less tax in 2009 than the previous year. So far, the only projections for 2010 changes are another tax bracket adjustment in the taxpayers favor.
Considerations
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When filing your W-4 with a new employer, make sure to claim as many allowances as you are able. The W-4 form calculates, per paycheck, the taxes and exemptions you will claim when you file your tax return for you. While many people often claim as little as possible to ensure a large refund check come tax season, this is not advisable. Essentially, you have just given the government an interest-free loan. Instead, claim all the allowances to which you are entitled and put that money in a savings account---you will end up with more in the end.
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