Does moving into a higher tax bracket mean all your income is taxed at the higher rate?

No. Only the dollars above the bracket threshold are taxed at the higher rate; everything below keeps its lower rates. Under hypothetical brackets of 10% up to $20,000 and 20% above, earning one dollar past $20,000 adds twenty cents of tax, and nothing about the first $20,000 changes.

What is the difference between marginal and effective tax rate?

The effective rate is total tax divided by total income, a blend of every bracket you pass through. The marginal rate is the rate on the last dollar. At $50,000 under the hypothetical brackets, total tax is $8,000, an effective 16%, while the next dollar is taxed at 20%.

Marginal Tax Rate: The Rate on Your Next Dollar of Gains

Crossing into a higher bracket raises the tax on the dollars past the line, and only on those. The belief that a raise or a good trading year can leave you worse off after tax, because the whole of your income suddenly gets taxed at the new rate, is a common misreading of how income tax works. The brackets stack.

Worked with hypothetical brackets

The brackets below are invented for illustration. Real brackets are set by law and adjusted by the IRS each year. Say income up to $20,000 is taxed at 10% and income above $20,000 at 20%.

Now add a trade. An extra $1,000 of short-term gain lands on top of the $50,000, all of it in the 20% bracket. Tax goes up by $200, twenty cents on each extra dollar.

That $200 is the number that matters for the decision. The 16% effective rate describes last year’s return as a whole. It tells you nothing about what the next trade, the next bonus or the next deduction does to your bill, and using it to estimate after-tax results will understate the cost of a gain and the benefit of a loss every time you sit in a bracket above your lowest one.

A gain that straddles a bracket

Large gains can span two brackets. Take someone with $15,000 of other income who books a $10,000 short-term gain under the same hypothetical brackets.

The marginal rate changed halfway through the gain. Each slice pays its own rate.

What it prices

A marginal rate turns tax items into dollars. At the hypothetical 20%:

$1,000 more short-term gain costs $200.
$1,000 of losses used against ordinary income saves $200. The IRS caps that use at $3,000 a year, so a full $3,000 saves $600, as the answer on how capital losses offset gains and income sets out.
$1,000 of deductible investment interest, if you qualify to deduct it, is worth $200. Whether margin interest is tax deductible depends on how you file and what the loan paid for.

Short-term gains, from positions held a year or less, are taxed as ordinary income at your marginal rate. Long-term gains and qualified dividends have their own separate rate schedule. Under a hypothetical 10% long-term rate, the same $1,000 gain would cost $100, and that difference is a large part of why investing and trading can end a year with the same pre-tax profit and quite different amounts left over.

Where you meet it

No line on a return is labeled “marginal rate.” You find it by locating your taxable income on the year’s rate schedule or tax table in the Form 1040 instructions and reading which bracket the last dollar falls in. Use the schedule for the right year. The thresholds move. The effective rate is easier: total tax divided by income, both on the return. Situations differ, and state income tax adds its own marginal rate on top.

What people get wrong

Believing a higher bracket taxes all income at the higher rate.
Using the effective rate to judge a trade.
Estimating a large gain at a single rate.
Treating a deduction as worth its face value.

Cost basis sets the size of the gain, and events like a return of capital change it. The effective rate is the average; the marginal rate is the edge. Phase-outs of credits and deductions can push the true marginal rate on some income above the bracket rate, since an extra dollar can be taxed and shrink a benefit at the same time, and planners sometimes call the combined figure an effective marginal rate.