Do You Know Your Income Tax Rates?

 

With 2023 tax season well underway, now is a good time to examine income tax rates, which are a percentage of taxpayers’ income that is taxed. 

The U.S. income tax system is progressive, which means that taxes take a larger percentage of income from taxpayers with higher taxable incomes. Federal marginal income tax rates are established by Congress and change periodically.

There are actually five tax rates that taxpayers should be aware of: marginal tax rate, short-term capital gains tax rate, long-term capital gains tax rate, the tax rate on dividends (qualified and non-qualified), and effective tax rate. Below is a brief description of each tax rate category:

 

Marginal Tax Rate- The tax rate applied to the last dollar that an individual (or married couple filing jointly) earns. Under the most recently passed tax law, the Tax Cuts and Jobs Act of 2017, there are currently seven income range segments for four tax filing status categories (single, married filing jointly, married filing separately, and head of household) that are taxed at increasing rates as income rises. 

The current marginal tax rates are 10%, 12%, 22%, 24%, 32%, 35%, and 37%. If someone is in the 22% tax bracket, portions of their income are taxed at 10%, 12%, and 22%.

 

The term “ordinary income” is frequently used to refer to income sources that are taxed at the marginal tax rates described above. Examples include salary, wage, commission, bonus, and tip income, rents and royalties, interest, and required minimum distribution (RMD) withdrawals from tax-deferred retirement savings accounts (e.g., 401(k)s, 403(b)s, and traditional IRAs).

 

Short-Term Capital Gains Tax Rate- A short-term capital gain (STCG) is the profit made on an investment that is held for a year or less. It is taxed at the ordinary income tax rates; i.e., the same marginal tax rate as the income sources noted above.

 

Long-Term Capital Gains Tax Rate- A long-term capital gain (LTCG) is the profit made on an investment that is held for a year and a day or longer. There are three LTCG tax brackets that are based on taxpayers’ taxable income and tax filing status. The LTCG tax rates under current tax law are 0%, 15%, and 20%.

 

Tax Rate on Dividends- The tax rate on dividends depends on three factors: taxable income, tax filing status, and whether a dividend is considered qualified or  nonqualified. Qualified dividends must meet certain IRS criteria and are taxed at 0%, 15%, and 20% (the same tax rate as long-term capital gains). 

Nonqualified dividends are taxed as ordinary income. The type and amount of each type of dividend is reported to taxpayers by investment custodians on a 1099-DIV form.

 

Effective Tax Rate- This tax rate takes into account the fact that higher ranges of income are taxed at progressively increasing rates. It is calculated by dividing the total amount owed on a tax return by total taxable income. 

For example, if a couple owes $25,000 on a $150,000 taxable joint income, their effective tax rate is $25,000 ÷ $150,000 = 16.7%, even though their 2023 and 2024 marginal tax bracket is 22%. An effective tax rate is always lower than a marginal tax rate.

This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.