While you may think that tax brackets are hardware used to hold up tax shelves, guess again. Tax brackets describe what percentage of the money we make Uncle Sam expects to receive. Our tax brackets are called progressive or incremental. That’s because the more you make, the higher your rate. Note that I’m not saying the more you make the more you pay, although that’s also true. I’m saying that as you make more money, the incremental money you make is taxed at a higher rate. This concept becomes clear when you look at projected tax tables for 2003.

There are additional tax tables reflecting other categories of tax filers, like married people filing separate returns and heads of household (translation: unmarried with children). But since we’re only trying to grasp a concept or two, let’s stick with the two most common: joint filers and single filers. A glimpse at the tables reveals what a progressive tax structure is all about. Looking at the table for single taxpayers, we see that in 2003, if you made $6,000 or less, you were in the 10% tax bracket. If you made more than $6,000 but less than $28,401, you were in the 15% tax bracket. And if you made more than $311,950, you're paying 38.6%.

Before we go on, let’s make sure we understand what we’re looking at. The term “taxable income” in the tables doesn’t refer to every dime you made. That would be your total income, your gross income, or simply your income. Taxable income, on the other hand, is what’s left after all your deductions and exemptions. (Pull out your most recent 1040 and you’ll see this amount somewhere around line number 40. You’ll be able to identify taxable income because it will be labeled “taxable income.”) So theoretically you could have an income of a million dollars, but if you have $994,000 worth of exemptions and deductions, you’d still be in the 10% tax bracket.

Now let’s revisit the term “progressive.” Remember, I said that the more you make, the higher rate you pay? Here we see it in action. Look again at the table for single taxpayers. The first $6,000 of taxable income is going to be taxed at 10%. So if that’s all you made, you’d owe $600, you’d be in the 10% tax bracket and that would be that. But say your taxable income was $25,000. Our table tells us that the first six grand is taxed at 10%, then the rest, $19,000, will be taxed at the next highest bracket, which is 15%. Our tax bill would be $6,000 x 10% + $19,000 x 15%. Total tax due? $3,450, which is a little less than 14% of our $25,000 taxable income. So, while we’re in the 25% tax bracket, we’re not paying 25% of everything we make in taxes. If our taxable income is $50,000, our total tax bill will be $9,792. We’re in the 27% tax bracket, and we’re paying a little less than 20% of our total taxable income in taxes.

I’m sorry to drag you through Tax Accounting 101, but I want you to understand what tax brackets are and what they’re not. What they are is a picture of how your incremental income (i.e., income after it crosses a certain threshold) is going to be taxed. What they’re not is a picture of how your total taxable income is going to be taxed.