Why You Need to Understand Tax Brackets

Most jurisdictions tax progressively. The more income you have, the higher your tax rate.

The income ranges on the left are called brackets. The rate corresponding to that bracket is the tax rate only on income inside that bracket. Let's say you had taxable income of $46,000 in a year. Under the above tax regime, your tax would be ­

            On the first 6,000 (6,000 X 10%)           $600.00

            On 27,950 - 6,000 (21,950 X 15%)        3,292.50

            On 46,000 - 27,950 (18,050 X 27%)      4,873.50

            Total tax                                             $8,766.00

Note that the higher rates apply only to the income in that bracket. Many people think, for example, that the 27 percent rate would apply to the entire $46,000. If you've ever heard anyone say something like "There's no point in me working overtime. They take more tax than the extra I make," you're listening to a person who doesn't understand brackets. Although you get to keep progressively less of each extra dollar you make, you will always keep some.

The same concept applies to corporations. Up to a certain income level, most small businesses get a preferential tax rate. On income over these levels, they pay a higher rate of tax.

The art of tax minimization involves finding the right blend of taxation between the corporation and you as its owner. You want to structure your situation so that you pay the least amount of tax in total.