Taxes are always a favorite topic of conversation, and frequently terms like tax rate and deductions are thrown around. N.C. State University’s Mike Walden shares insight on what these words and phrases really mean.
“And, of course … , this is a big, big topic, and … we’re just going to scratch the surface here.
“When you’re talking about tax rates, there are two important rates, and they are different: The average tax rate is simply the tax paid as a percent of your income — so,all of your taxes paid as a percent of your income
“The marginal rate — some call it the tax bracket — is the tax that you would pay on additional income. And often that is different than the average rate, particularly because with our federal income tax, marginal rates go up as your income goes up.
“But it’s important to know that people don’t pay that higher marginal rate on all their income. It’s simply on additional income.
“A deduction is income that a person spends in a certain way that is highlighted by the tax code, and the tax code says, ‘Hey, you can take that spending and not pay taxes on it.’ A good example would be interest paid on a mortgage. That is allowed as a deduction, which effectively means you don’t have to pay tax on the income behind that spending.
“And then a tax credit — this is … really valuable. A tax credit is spending that someone does that, no, they don’t get to take as a deduction; they actually get to take that and reduce their entire tax bill. So that’s much more valuable.
“So, average tax rate, marginal tax rate, deduction, and credit are four key tax terms that people should be familiar with.”