Wikipedia has a great explanation of tax brackets and sample tax calculation. Click here and read through it. The rates shown are for 2009, but the concept shown holds true.
In the example (we’ll look only at federal taxes) John and his wife have a combined income of $112,000, putting them squarely in the 28% tax bracket. On the surface, you might think their taxes would be $112,000 x .28 = $31,360. But, that type of math is too simple for the government. After subtracting 401(k) contributions and other benefits, itemized deductions, and personal deductions, John’s new taxable income, called adjusted gross income (AGI), is $56,650, according to the example.
One thing to note is that ours is a progressive tax system. That means, the more you earn, the greater the percentage tax on amounts above a certain limit. So, John’s first $16,700 is taxed at 10%. Then, amounts from $16,701 to $67,900 are taxed at 15%, and so on. Using the 2009 rate scale in the article, his federal taxes now look like this:
$16,701 x .10 = $1670.00
($56,650 - $16,701) x .15 = $5992.35
$1670.00 + $5992.35 = $7662.35 Total Federal Taxes
By paying this amount, John’s effective tax rate is much different than the tax bracket he is in. He effectively pays only 6.84% in federal taxes. Of course, there are other taxes he has to pay, such as Social Security and Medicare, as well as state and local taxes, which increase the total effective percentage he pays. Don’t be fooled into thinking that your tax bracket is the actual amount that you pay. It indicates the amount of tax you will pay on the next dollar earned – above your AGI.