Tax Calculation Example

Tax Calculation Example

Mary is a single taxpayer with $350,000 of taxable income. Her income is taxed in each of the tax brackets, as follows:

• $755.00 (tax on the first $7,550 of Mary's income, taxed at the 10% rate), plus
• $3,465.00 (tax on the income between $7,550 and $30,650, taxed at the 15% rate), plus
• $10,887.50 (tax on the income between $30,650 and $74,200, taxed at the 25% rate), plus
• $22,568.00 (tax on the income between $74,200 and $154,800, taxed at the 28% rate), plus
• $59,977.50 (tax on the income between $154,800 and $336,550, taxed at the 33% rate), plus
• $4,707.50 (tax on the income over $336,550, taxed at the 35% rate), for a grand total tax of
• $102,360.50.

Mary's income tax is $102,361 (rounding up). This tax consists of $4,707.50 tax on the amount over $336,550 (the income in the 35% tax bracket) plus $97,653.00 (the tax on income in the lower tax brackets). Mary's marginal tax rate is 35%. The next dollar Mary earns will be taxed at 35%. However, Mary's average tax rate is 29% (total tax divided by taxable income). On average Mary is paying only 29 cents for every dollar of taxable income she earns. Mary's average tax rate is lower than her marginal tax rate because most of her income is taxed at lower tax rates.
We can compare the changes in the marginal tax rates by comparing Mary's total tax using 2005 tax rates and 2004 tax rates. If Mary had the same taxable income of $350,000 in 2006, 2005, and 2004, her total tax liability would have been $102,970 in 2005 and $103,408 in 2004. Mary's taxes are lower in 2006 because of changes in the income tax brackets.