Tax brackets are features of progressive tax systems or systems that include marginal tax rates. Each bracket represents a threshold. Taxable income that falls above the cutoff value is typically taxed at a higher rate, while taxable income below the threshold figure is usually taxed at a lower percentage.
International tax codes frequently include brackets for both individual and corporate income taxes. In the United States, tax brackets are found in both federal and state income tax systems. However, state tax brackets vary widely—while some states have just a few income tax brackets, others have nine or more.
Congress establishes the tax brackets outlined in the Internal Revenue Code (IRC). Since income in higher tax brackets can be subject to significantly higher tax rates, individuals and corporations have incentives to manage and reduce taxable income. Best practices include the following:
- Know your tax bracket. Tax brackets change periodically, so it's important to verify federal and state tax brackets during annual tax planning routines. By understanding income thresholds, you can develop strategies to keep taxable income out of higher tax brackets.
- Use deductions to avoid high tax brackets. For individuals, deductions are the most effective way to reduce taxable income and avoid higher tax rates on the portion of income that falls above established thresholds. In addition to itemized deductions, taxpayers may be entitled to deduct amounts for IRAs, self-employment tax and other expenses.
- Actively manage your effective tax rate. Corporations can use a combination of deductions, tax deferrals, tax credits and other strategies to minimize taxable income. Many corporations use these tactics to avoid higher tax brackets and significantly reduce their effective tax rates.
Currently, in the United States, statutory corporate tax rates applied to the corporate tax brackets, as defined in the IRC, range from 15 percent on the first $50,000 of taxable income up to 35 percent on income over $18.3 million. Higher corporate tax rates (as high as 39 percent) are applied within some tax brackets to phase out the benefits of the lower rates. For personal income taxes, the bracketed tax rates vary from 10 percent to 39.6 percent.