Confusion about tax bracket?

Question

So until last year, I was least concerned about tax brackets because I was getting money back every year. However, my wife started working this year and sounds like we do owe some money to uncle SAM this year.

Now, I started looking into different kind of tax deductions(401k, IRA, charities etc) and I was also referring to the tax bracket here:

on Married Filing Jointly table. Our house hold income last year was 185k and with 401k Contribution, I brought it down to 160k(taxable income).

Now, If I am interpreting the table correctly, if I reduce my taxable income further down by 10k(which will be below 151k tax bracket), I should see significant amount of reduction in the tax amount that I owe to government because

1. Not only by Percentage of tax went down from 28% to 25%(almost 3% decrease)
2. but also, my base rate would go down from almost 29k to 10k(almost 20k, which is HUGE)

So while I was on Turbo Tax, Just for fun I entered 10000 as Charity JUST TO SEE that if I see any significant decrease in amount of tax that I owe. I was expecting (3% at 150k (4500) + 20k base reduction = 24k less in taxes). However, what I saw was ONLY 3 thousands payable tax going down.

What am I missing?

Answer 1

You are not interpreting the table correctly. The $20K "base rate" that you think should have been eliminated is in fact the total tax for the whole bracket. You only dipped partially into the bracket, and the $3K reduction accounts for that.

Look at the table again:

Over            But not over                            of the amount over
$50,400     $130,150    $6,897.50   +   25%         $50,400
$130,150    $210,800    $26,835.00  +   28%         $130,150

What it means is that if you earn $100K, you will pay $6897.50 + 25% of (100000-50400) = $12400.

If you earn $140000, you'll pay $26835 + (140000-130150) * 0.28 = $2758.

So why the difference between $26835 and $6897.50? That's exactly 25% of $79500, which is the difference between $130150 and $50400 - the whole value of the bracket.

Answer 2

Most of the time, your tax only reduces by the current marginal rate - meaning you would only reduce your tax by 28% to 25% depending on which part of the bracket you're in.

However, in the area around 100k, there are cases where reductions will have more of a marginal effect than that. You'll never reduce it more than 100%, but you can reduce it by 35-40% despite being in the 25% bracket.

That is because of certain deductions and credits which phase out beginning around 80k-120k; things like the IRA deduction, the Child Tax Credit, Childcare Tax Credit, and similar. Since many of them phase out in this range, additional dollars cost you your marginal rate (25%) plus the percentage of the credits or deductions which phase out here, which might bring you up another 10% or so.