Tax Brackets

Published Oct 26, 2023

Definition of Tax Brackets

Tax brackets refer to specific ranges of taxable income that determine the rate at which an individual or business is taxed. In other words, tax brackets indicate the percentage of income that must be paid in taxes for each designated income range. The tax brackets are typically set by the government or tax authorities and are used to determine the amount of tax owed by taxpayers.

Example

Let’s look at an example to better understand tax brackets. Assume that the tax system has three tax brackets: 10%, 20%, and 30%. The first tax bracket applies to income up to $50,000, the second tax bracket applies to income between $50,001 and $100,000, and the third tax bracket applies to income above $100,000.

Now, imagine an individual named Sarah who earns $60,000 per year. Her income falls within the second tax bracket. This means that the first $50,000 of her income will be taxed at a rate of 10%, while the remaining $10,000 will be taxed at a rate of 20%. Sarah’s total tax liability can be calculated by multiplying each portion of her income by the corresponding tax rate and adding them together.

It’s important to note that tax brackets are progressive, meaning that higher income levels are subject to higher tax rates. This ensures that individuals with higher incomes bear a larger tax burden compared to those with lower incomes.

Why Tax Brackets Matter

Tax brackets are a crucial component of the income tax system. They help determine the fairness and progressiveness of the tax system, as individuals with higher incomes pay a higher percentage of their income in taxes. Tax brackets also play a role in determining the amount of tax revenue generated by the government, as higher income earners contribute a larger share of the overall tax revenue.

Understanding tax brackets is important for individuals and businesses to effectively plan their finances and budget for tax obligations. By knowing the applicable tax rates based on their income, individuals can make informed decisions about savings, investments, and expenditures. Additionally, businesses can consider the tax implications of hiring new employees or increasing wages for existing employees, as these changes may affect the tax bracket they fall into.