How are Income Tax Brackets Calculated?
Income tax brackets are determined based on a progressive tax system, which means that individuals pay different tax rates on different portions of their income. This system is designed to ensure that those who earn more contribute a fairer share of their income in taxes.
1. Determining Taxable Income
The first step in calculating income tax brackets is determining an individual's taxable income. This is done by taking the total income and subtracting any deductions (standard or itemized) and exemptions. The result is the amount that will be taxed.
2. Establishing Income Thresholds
Tax brackets are defined by specific income thresholds, which are set by tax authorities. Each bracket corresponds to a different tax rate, ranging typically from 10% to 37% in the U.S. The thresholds can change annually based on inflation adjustments or legislative changes.
3. Applying the Tax Rates
Once the taxable income is established and the tax brackets identified, the applicable tax rate is applied to the income within each bracket. For example, if a taxpayer falls into a 22% bracket, only the portion of income within that bracket is taxed at that rate, while lower portions may be taxed at lower rates.
4. Calculating Total Tax
Finally, the total tax is calculated by summing the taxes owed from each bracket. This method ensures that taxpayers only pay higher rates on income earned over certain thresholds, promoting fairness in the taxation system.