February 11, 1996|By SUSAN BONDY | SUSAN BONDY,Creators Syndicate

You often mention tax brackets in your columns. Can you please explain what they are? My gross income last year was $41,500, and my taxable income was $27,118.

How do I figure out my tax bracket, and what are the practical implications of knowing my tax bracket?

A tax bracket is another name for a tax rate. The federal government charges progressively higher tax rates on income. As your taxable income increases, so does the tax rate you pay on top dollars of earnings.

Here's how it works: For the 1995 tax returns, there are five tax brackets: 15 percent, 28 percent, 31 percent, 36 percent and 39.6 percent. A single filer with one exemption pays a 15 percent federal tax up to $23,350 of taxable income. On earnings between $23,350 and $56,550, a 28 percent rate is charged; between $56,550 and $117,950, there is a 31 percent rate; between $117,950 and $256,500 of taxable income a 36 percent rate is applied; and a 39.6 percent rate applies to taxable income over $256,500.

Although your top dollars of taxable income are in the 28 percent tax bracket, your federal tax for this year will only be 17.09 percent ($4,636) of your total taxable income of $27,118 -- assuming your earnings will stay the same as last year. On the first $23,350 of your income, a 15 percent tax would be levied ($3,502.50). Add to that 28 percent of the remaining $3,768 ($1,055.04) -- for a total of $4,557.54.

A married couple filing jointly with two exemptions pays 15 percent up to $39,000 of taxable income. Earnings between $39,000 and $94,250 are taxed at 28 percent; between $94,250 and $143,600 there is a 31 percent tax; between $143,600 and $256,500, a 36 percent rate applies; and a 39.6 percent rate is charged on taxable income over $256,500.

Your top tax bracket, the tax rate on your highest dollars of earnings, is important to know for at least two reasons -- to calculate after-tax investment gains and interest and to know the true cost of tax-deductible loans, like a mortgage on your home.

Let's look at two examples:

Investments: If you own a 6 percent certificate of deposit (CD) that is fully taxable, after taxes, you'd be left with: 5.10 percent at the 15 percent tax bracket, 4.32 percent at the 28 percent, 4.14 percent at the 31 percent, 3.84 percent at the 36 percent, and 3.624 percent at the 39.6 percent.

As you can see, the return on your investment varies widely among the different tax brackets. State and local income taxes further reduce after-tax yields.

Mortgage: Assume your mortgage payment comes to $1,100 a month, of which $1,000 is interest. Since mortgage interest is deductible, here's how your tax bracket will affect your bottom-line cost:

At the 15 percent tax rate, your mortgage interest will cost $850, so your real mortgage cost is $850 plus $100 of principal, or $950 a month.

At the 28 percent bracket, the mortgage interest will cost you $720 after tax, and your mortgage cost will be $820 a month.

At the 31 percent bracket, the mortgage interest will cost $690, and your mortgage cost will be $790 a month.

Given your taxable earnings of $27,118, you have $3,768 on which you pay a 28 percent federal tax since you only pay 15 percent on your first $23,350 of income. If your taxable earnings remain the same in 1996, you will be able to save 28 percent on your first $3,768 of mortgage interest.