Our income is taxed in a progressive manner. As your income increases, it slips into higher tax brackets where it's taxed at a higher rate. But before your income is subject to these tax brackets, it must exceed your exemption and standard deduction. Otherwise you pay no tax.
*Tax-free thresholds and filing status:
For 2013, your personal exemption is $3,900 no matter what your filing status is.
If you are filing single then your standard deduction is $6,100; it with your personal exemption totals $10,000. So, if you're filing as 'single' then $10,000 is your tax threshold; you're only taxed on income greater than this.
If you're filing married, your standard deduction is $12,200 - twice the single standard deduction. Increasing this amount by two times the personal exemption makes the married tax threshold $20,000. You can see it's just 2 x the single filing standard deduction and tax threshold.
Only that amount of income beyond threshold is taxed at the income tax rates given below - for single and for married filers.
If, as a single filer, you're 65 or older your standard deduction is increase by $1,200 to $7,300 putting your tax-free threshold at $11,200. You also get another $1,200 increase if you are blind.
And if you're both over 65 and married filing jointly, your tax-free threshold doubles to $22,400.
So now that you know your tax-free income threshold, let's see what the income tax rate is on any income that exceeds your threshold as a single and as a married filer.
*Income tax brackets:
Income is excess of your appropriate tax-free threshold is subject to federal income tax. The tax rate depends on that excess income above your threshold income. The excess income has a tax bracket amount and tax rate that depends on your filing status.
These bracket rates are: 10 % beginning at $1 excess for single and $1 also for married filing jointly; then it jumps to 15% above an excess of $8925 for single and $17,850 for married; then 25% for excess income above $36,250 single and $72,500 for married; 28% above $87,850 single and $146,400 married, 33% above $183,250 single and $223,050 married, 35% $398,350 single, $398,350 married, 39.6% $400,000 single and $450,000 married. You can see that the rates converge for same income whether single or married at higher incomes.
*Investment tax rates:
Your investment income that's subject to yearly taxation (i.e. not part of a tax-deferred qualified plan) is composed of interest, dividends and capital gains and losses from sales in that year. All interest income is added to your working income. So it's subject to your highest tax bracket rate if you consider it's added on top of your working income.
All non-qualified dividends and short term (held for 1 year or less before selling) capital gains are added to your working income just like your interest income. So they're taxed at the highest tax bracket rates they bring you into.
Both long term capital gains and qualified dividends are taxed at lower tax rates. Presently, that rate depends on your excess income and brackets are ascribed to these rates too.
The rates for both your long term capital gains and qualified dividends have a rate based on your excess income and your filing status. These bracket rates are: 0% (i.e. there's no tax) for single below $36,250 and for married below $72,500; 15% for single above $36,250 and for married above $7250; and the last bracket is at 20% for single above $400,000 and married above $450,000.
Now that you know how you will be taxed on what income, you can plan to minimize your exposure to higher tax rates by deferring gains or taking capital gain losses, or other approaches.