Taxing Matters

A Message from Kimberly Clouse, Financial Expert:

kim_clouse I have worked in the financial services industry for nearly a decade in many capacities, most recently as a financial adviser for individuals. Over the course of my career, I have had the privilege of working with a diverse range of people, from the single mother just starting her own business to the billionaire. Based upon my experiences, I have learned that the same basic principles and lessons apply to a successful and healthy financial life, whether you’re starting out or cashing out. These guiding principles include simplicity, a long-term perspective, and above all, knowing that you have control of your financial destiny, and all the information you need is well within your reach.

Taxing Matters

Taxes tend to make people’s eyes glaze over. Nonetheless, it is important to know your marginal tax rate when making investment decisions. For instance, the cost of selling a stock held for less than a year will be higher for someone in the 31% bracket than for someone in the 28% bracket. Also, the higher your tax bracket, the more appealing investments like tax-free municipal bonds become.

Before we launch into the differences between marginal and effective rates, let’s discuss two definitions that are helpful when thinking about the tax that you actually pay on your income:

  • Gross income is your total income from all sources, unless specifically excluded by tax law (e.g., tax-exempt bond interest).
  • Taxable income is calculated by subtracting all your allowable adjustments, deductions, and exemptions from gross income. Tax rates are applied to taxable income to determine how much tax is due.

Two tax rates are important in understanding how your income is taxed: your marginal tax rate and your effective tax rate.

  • Marginal tax rate is the rate applied on your last dollar of earnings. To illustrate this concept, assume that the tax system only has two rates: 10% on the first $20,000 of income and 20% on income in excess of $20,000. If you received a salary of $25,000 and a bonus of $2,500, your marginal tax rate on the bonus (and $5,000 of your salary) is 20%. Your marginal rate will also tell you the effective tax savings of deductions. For example, a $1,000 deduction for someone with a marginal tax rate of 28% gives an effective tax savings of $280 ($1,000 x 0.28).
  • Effective tax rate is calculated by dividing the total tax paid by your total income and is therefore the overall rate at which your income is taxed. Using the example above:
    • Your total income is $27,500 ($25,000 salary + $2,500 bonus).
    • The tax on your first $20,000 of income is $2,000 ($20,000 x 10%).
    • The tax on the next $7,500 is $1,500 ($7,500 x 20%).
    • So the total tax due is $3,500 ($2,000 + $1,500).
    • Therefore, the effective tax rate is only 13%, or $3,500 total tax divided by $27,500 total income. Compare this with the 20% top marginal tax rate in this example.

Marginal tax rates result from the IRS’ graduated tax system, and people pay an increasing percentage as their income rises through various brackets. Simply put, the IRS charges different tax rates for different levels of your taxable income.

In general, at the federal level, taxpayers fall into 5 marginal tax brackets.

For an example, in 1999, those tax brackets were: 15%, 28%, 31%, 36% and 39.6%. Check with for this years’ current deductions. (While most Americans fall into one of the 5 tiers, for some people, the top tax rate effectively exceeds 39.6%, as itemized deductions and exemptions are phased out beyond certain income levels.)

In this tiered tax system, you pay 15% on the first tier of taxable income–for a single person in 1999, the first $25,750 in earnings. You pay 28% in taxes on the next tier–again, for a single person in 1999, this applies to income between $25,750 and $62,450. In accordance with the marginal tax system, you pay increasing percentages as your income rises, reaching a 39.6% rate on all income over $283,150. Refer to the sample chart below from the year 1999. Should you want to learn more about your particular tax rate for the current year and their effect on your financial situation, visit the official Web site of the Internal Revenue Service,


Married filing joint or surviving spouse

Head of household

Married filing separately

15% if your taxable income is over:

$ 0

$ 0

$ 0

$ 0

28% if your taxable income is over:

$ 25,750

$ 43,050

$ 34,550

$ 21,525

31% if your taxable income is over:

$ 62,450


$ 89,150

$ 52,025

36% if your taxable income is over:




$ 79,275

39.6% if your taxable income is over:





Should you want to learn more about tax rates and their effect on your financial situation, visit the official Web site of the Internal Revenue Service.

This column is designed to provide accurate and authoritative information on the subject of personal finances. It is provided with the understanding that the Author is not engaged in rendering legal, accounting, or other professional services by publishing this column. As each individual situation is unique, questions relevant to personal finances and specific to the individual should be addressed to an appropriate professional to ensure that the situation has been evaluated carefully and appropriately. The Author specifically disclaims any liability, loss or risk which is incurred as a consequence, directly or indirectly, of the use and application of any of the contents of this work.