When you hear that anyone earning over $406,750 pays taxes at the rate of 39.6 percent, you may imagine that such a person pays taxes at this rate on all income. It is not the case. The top federal income tax rate for 2015 is 39.6 percent, but the average rate paid by anyone with income in the top bracket is lower, a blend of seven different rates beginning at 10 percent.
Graduated Income Tax Rates
To get a better understanding of U.S. federal tax rates, consider the 2015 tax brackets for taxes due April 15, 2015, such as the one provided by Bankrate. A single filer with income up to $9,075 pays taxes at the rate of 10 percent. On income above that, up to a limit of $36,900, the filer pays 15 percent. From $36,901 to $89,350 the filer pays taxes at the rate of 25 percent. There are seven rate brackets in all, with the maximum rate of 39.6 percent on all income above $406,751.
A Tax Isn't a Punishment for Being Successful
You may occasionally hear someone with a high income complain that he's paying "almost 40 percent" of his income in federal income taxes. You may possibly conclude from this that the more money you make, the more heavily your money is taxed. But this isn't quite true. If you make more than $406,751, the income above that cutoff is taxed at 39.6 percent. But the income on the first $9,075 of a millionaire's income is taxed at the same rate as a part-time McDonald's employee's first $9,075 -- 10 percent. To know that taxpayer's actual average tax rate, you need to calculate the taxable amount according to the rate for each bracket, then determine the average rate based on those amounts. It's not a difficult calculation.
A $500,000 Test Case
Let's take as an example someone with taxable income in 2015 of $500,000. On the first $9,075 of income, she pays 10 percent, or $907.50. Above that income amount and up to $36,900, she pays 15 percent. To find out how much that is, subtract $9,075 from $36,500, which is $27,500, and multiply that by 15 percent. The taxable amount in this bracket is $4,173.75. Continue this process for the remaining five brackets, subtracting from the maximum amount in each current bracket the maximum amount of the previous bracket, then multiplying that net amount by the rate for that bracket. The taxable amounts in each of the seven brackets are:
$907.50, $4,173.75, $13,112.50, $27,160.00, $72,187.50, $577.50 and $36,927.00
Adding these bracket amounts together results in a total tax payment of $155,045.75
The Average Tax Rate
To find the average rate this filer paid, divide the tax, $155,045.75, by her 2015 taxable income of $500,000. The average tax rate was 31 percent.
An individual earning $500,000, then, pays 39.6 percent on income above $406,750, but within each bracket, everyone pays the same rate, starting at the lowest rate of 10 percent. Although slightly more than half of all Americans polled in 2014 thought income taxes were too high, according to the nonpartisan Tax Foundation, the average tax rate paid by all Americans in 2010 was 11.81 percent. As a result of various deductions, the average effective tax rate for the wealthiest 1 percent in that year was actually only 23.39 percent.