Just what percentage of your income do you pay in taxes? If we're talking about federal income tax, the answer is: It depends. Let's say that after you took all of your deductions, you arrived at a taxable income of £130,000. Based on the federal tax rates for 2010, you are in the 33 per cent tax bracket. But that just tells you that you paid 33 cents in taxes on the last dollar you earned. Your average tax rate is much lower. To figure out why requires some basic math.
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Estimate your average tax rate quickly. The simple way is to look at your final tax bill and divide it by your total taxable income. Now let's see how the government arrives at the figure.
Look at how your tax rate changes with your income. Under a progressive tax system, you pay lower taxes on the first dollar you earn than you do on the last dollar. To make this easy to understand, let's say the tax brackets are set up as follows: 10 per cent on £0 to £6,500; 20 per cent on £6,500 to £32,500; and 30 per cent on £32,500 to £65,000. (For actual federal tax brackets, see Resources.)
Do the math. Let's say your total taxable income is £52,000. Here is what you would pay: £650 on your first £6,500; then £5,200 on your next £26,000 (50,000 - 10,000 = 40,000 x .20); and £5,850 on your next £19,500 (80,000 - 50,000 = 30,000 x .30). The total comes to £11,700.
Compare average and marginal rates. Your average rate is 18,000 divided by 80,000 or 22.5 per cent. Your marginal rate is the tax you paid on the last dollar you earned. In our example, the tax rate on every dollar earned over £32,500 is 30 per cent.
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