Understanding the difference between marginal tax rates and effective tax rates is crucial for accurate tax planning. The marginal tax rate is the rate applied to your last dollar of income, while the effective tax rate is the average rate you pay on all your income. A common misconception about taxes is that a 40% top tax rate means you’ll pay 40% of your taxable income in taxes. In reality, the U.S. uses a graduated income tax system, where your top, or marginal, tax rate only applies to the income within that bracket. For instance, many think a 24% tax rate on $100,000 of taxable income means $24,000 in taxes. However, the 24% rate only applies to the last $5,000 of income. The first $11,000 is taxed at 0%, the next $33,000 at 12%, and the following $50,000 at 22%. This results in approximately $17,000 in taxes. Your effective tax rate, which is the average rate you pay, would be 17%, even though your marginal rate is 24%. Note that these figures are for illustrative purposes only and your rates will vary.