What does it mean to have a Progressive Tax System?
Thankfully by now, most of us are done with our 2024 tax returns and can cross this big “to do” off our list.
But that doesn’t mean the work of tax planning is done, and as many of you know, keeping an eye on taxes is something we take seriously around here.
We often talk about “filling up a tax bracket” or using up a bracket to its fullest potential. And it dawned on us that perhaps this lingo needed to be explained better in non “tech” terms.
You see, generally speaking, in the US we operate under a progressive tax system. This means that there are tiers, or “brackets”, with different rates. Each tier gets filled up from the bottom up, until it spills over into the next tier.
When we talk about a client being in the “24%” tax bracket, that doesn’t mean their taxable income gets taxed at 24%, but that this is the last “tier” their income flowed into after filling up the rest of the tiers.
Think of our tax system as a fountain with several tiers. The water flows from the smallest tier to the largest tier, filling each tier as it goes. The next biggest tier doesn’t get water until the smaller tier above it is filled up. And if the water stops, the next largest tier does not have anything spilling into it.
For 2025, if you are “Married Filing Jointly”, your tiers are as follows:
Tax Rate | Married Filing Jointly |
10% | $0 – $23,850 |
12% | $23,851 – $96,950 |
22% | $96,951 – $206,700 |
24% | $206,701 – $394,600 |
32% | $394,601 – $501,050 |
35% | $501,051 – $751,600 |
37% | Over $751,600 |
As an example, if your taxable income (generally your annual income, minus your standard – or itemized – deduction), is $110,000, your income will be taxed at the various “tiers” it fills up – some at 10%, some at 12%, and some at 22%.
This is what is meant by a progressive tax system.
While in our example above, these clients are in the “22%” tax bracket, their actual tax rate (or their “effective”/”average” tax rate), is more like 13%.
This is important because in our tax planning with clients, we are always looking for opportunities to invest and manage assets as tax efficiently as possible.
For instance, if we have a client who just barely tipped into the 22% tax bracket, maybe this is the year that it makes sense to do a Roth Conversion, and “fill up” the 22% tax bracket, with the belief that in future years, the client will actually be in a higher tax bracket and we are taking this opportunity today to pay a lower amount of taxes.
This is a general and simplified overview of how our tax system works (there are dozens of qualifiers: Social Security Income, short or long-term capital gains, net investment income, dividends and interest), but this is something we look at each year with our clients that give us copies of their tax returns. We are looking for opportunities to save taxes.
If you haven’t sent us your 2024 tax returns for review yet, you can upload them to your eMoney Client Vault, or send us an email and we can send you a secure link for upload.
Thank you for trusting us to be on your team! We are ever grateful for the opportunity.
Your IWC Team
Disclosure: We are not licensed to give tax advice – please always seek tax advice from your licensed professional.
