Some people worry that if their income increases enough to push them into a higher tax bracket, their overall take-home pay, or net income, will decrease. They might think that getting a raise, especially a small one that nudges them into that next bracket, will actually hurt them.
Fortunately, that isn’t how the U.S. tax system works. Let’s break down this misconception so that you have one less thing to worry about and can accept your next raise gladly.
- The U.S. tax system is based on marginal tax brackets, with different levels of income taxed at different rates.
- Tax exemptions and deductions mean that you never pay tax on your entire income.
- Increasing your income might move you into a higher marginal tax bracket, but you’ll only pay a higher tax rate on the last dollars that you earn.
- You might become ineligible for certain social services and tax breaks after getting a raise.
How Tax Brackets Work
The U.S. has a progressive tax system, using marginal tax rates. What does this mean?
- “Progressive” means that as you make more, you pay a higher tax rate. The idea is that those who can afford it should pay more in taxes. There are a lot of flaws and loopholes in this premise, as well as broader problems with the American tax system, but that’s the idea.
- “Marginal” refers to the part of your income on which you pay the higher rate. It means that the higher rate doesn’t apply to all of your income, just income above a certain threshold. The Internal Revenue Service (IRS) sets these thresholds and adjusts them as needed to account for inflation.
Here’s an example: An unmarried manager who earns $150,000 and an unmarried retail clerk who earns $30,000 will both pay 10% on their first $10,275 of taxable income in 2022 (rising to $11,000 in 2023). However, the manager will pay a rate as high as 24% on some of their income, while the clerk won’t pay more than 12% on any of their income.
The concept of a marginal tax bracket is probably easiest to understand with an illustration. Here are the tax rates that single (unmarried) people will pay on the income that they earn in 2022. (It is followed by the tax rates single people will pay on the income that they earn in 2023).
|Marginal Tax Rates for Taxpayers Filing as Single 2022|
|$0 to $10,275||10% of taxable income|
|$10,275.01 to $41,775||$1,027.50 plus 12% of the amount over $10,275|
|$41,775.01 to $89,075||$4,807.50 plus 22% of the amount over $41,775|
|$89,075.01 to $170,050||$15,213.50 plus 24% of the amount over $89,075|
|$170,050.01 to $215,950||$34,647.50 plus 32% of the amount over $170,050|
|$215,950.01 to $539,900||$49,335.50 plus 35% of the amount over $215,950|
|$539,900.01 or more||$162,718 plus 37% of the amount over $539,900|
|Marginal Tax Rates for Taxpayers Filing as Single 2023|
|$0 to $11,000||10% of taxable income|
|$11,000.01 to $44,725||$1,100 plus 12% of the amount over $11,000|
|$44,725.01 to $95,375||$5,147 plus 22% of the amount over $44,725|
|$95,375.01 to $182,100||$16,290 plus 24% of the amount over $95,375|
|$182,100.01 to $231,250||$37,104 plus 32% of the amount over $182,100|
|$231,250.01 to $578,125||$52,832 plus 35% of the amount over $231,250|
|$578,125.01 or more||$174,238.25 plus 37% of the amount over $578,125|
Here’s an example of how to apply the information in this table:
Let’s say you have a taxable income of $60,000 in 2022, and you file as an unmarried taxpayer.
- The first $10,275 is subject to 10% tax
- The next $31,500 is subject to 12% tax
- The remaining $18,225 is subject to 22% tax
Notice that we said “a taxable income of $60,000,” not “a salary of $60,000” or “total wages of $60,000.” Your actual earnings might be $72,950. After subtracting the standard deduction of $12,950 (for 2022), your taxable income is $60,000. You don’t owe any federal income tax on the first $12,950 of your income. The standard deduction for single filers rises to $13,850 in 2023.
A More Advanced Example
Now that you understand the basics of marginal tax rates, let’s build on the last example to see exactly what happens to your taxes when you move into a higher tax bracket.
Suppose your taxable income is $40,000 a year and you get a $2,000 raise, making your taxable income $42,000. Previously, your highest tax bracket was 12% because your income didn’t exceed $41,775. Now your highest tax bracket is 22%. But only $225 of your income ($42,000 - $41,775) will be taxed at that rate. The rest will be taxed at 12% or less. Here’s how it breaks down:
- You will be taxed at a rate of 10% on the first $10,275 of taxable income—or $1,027.50.
- Then, you will be taxed at 12% on the next $31,500 of income—or $3,780.
- Finally, you will be taxed at 22% on the remaining $225 of your income—or $49.50.
So, your total tax will be $4,857. That works out to an overall tax rate of about 12% on the part of your income that’s taxable. (Your effective tax rate will be lower because of deductions and credits.)
Now, suppose you hadn’t gotten the $2,000 raise.
Using the same math as above, your tax bill (on $40,000 in income) would be $4,594.50 (10% × $10,275 + 12% × $29,725).
Bottom line: Your $2,000 raise has added $262.50 to your taxes, but you’re still ahead by $1,737.50.
An Exception to the Rule: Income-Restricted Benefits
Earning more income can, in fact, leave you with less money if it eliminates or reduces your eligibility for certain social services, tax credits, or tax deductions. Here are some examples:
- Premium tax credits for Health Insurance Marketplace plans
- Student loan interest deduction
- Lifetime Learning Credit
- Stimulus payments
- Mortgage insurance premium deduction
- Saver’s credit
Another Consideration: How Much Will You Give Up to Earn Less?
As your marginal tax rate increases, you get to keep less and less of each extra dollar that you earn. If you have to work harder or work longer hours to get those extra dollars, there’s going to be a point when it’s no longer worth it to you.
For example, if you’re financially comfortable, you might not want to work weekends if you’re only keeping $76 of every additional $100 that you earn—and that’s only accounting for federal income taxes.
Social Security takes another 6.2% cut until you reach the annual Social Security earnings limit ($147,000 in 2022 and $160,200 in 2023), and Medicare takes another 1.45% no matter what your income is.
If you’re self-employed, you also pay the employer share of Social Security and Medicare, also known as the self-employment tax.
High earners also pay an additional 0.9% Medicare tax on income that exceeds a certain amount.
Now you know why wealthy people try to minimize their earned income (it’s highly taxed) and maximize their investment income (it’s often less taxed)—and why tax analysts say marginal tax rates are a disincentive to work.
Steve Stanganelli, CFP®, CRPC®, AEP®, CCFS
Clear View Wealth Advisors LLC, Amesbury, Mass.
A raise could put you in alternative minimum tax (AMT) territory, where you may lose the ability to claim certain itemized deductions. For 2022, the AMT exemption is $75,900 for single taxpayers and $118,100 for married taxpayers filing jointly (rising to $81,300 for single taxpayers and $126,500 for married taxpayers in 2023).
In addition, a marginal increase in income could raise your Medicare Part B premiums two years later. This is only a concern for those who are (or will soon be) 65 or older. In 2022, higher Part B premiums apply when your modified AGI (modified adjusted gross income, or MAGI) is above $91,000 for single filers or above $182,000 for married joint filers.
You’ll want to review the tax implications before doing a Roth IRA conversion, since it could bump you into a higher bracket.
Also, the net investment income tax of 3.8% may impact you if your 2022 MAGI exceeds $200,000 (single filers) or $250,000 (married joint filers).
How can I avoid moving into a higher tax bracket?
One popular strategy for staying in a lower marginal tax bracket is timing your income. If you want to sell some stock that has increased in value, you might choose to sell it next year instead of this year, if selling it this year would push you into a higher tax bracket and selling it next year might not.
What’s the highest tax bracket?
In 2022, the highest marginal tax rate on earned income is 37%. It applies to amounts over $539,900 for single taxpayers and amounts over $647,850 for married taxpayers filing jointly. In 2023, the highest rate is also 37%, applying to amounts over $578,125 for single taxpayers and amounts over $693,750 for married taxpayers filing jointly.
Does my tax bracket affect all of my income?
No. Your tax bracket only affects a portion of your income. For example, as a single filer with a taxable income of $50,000 in 2022, your tax rate would be 10% on the first $10,275, 12% on the next $31,500, and 22% on the remaining $8,225. You will not pay 22% on all $50,000.
The Bottom Line
The next time you receive a raise, don’t let concerns about tax brackets dampen your enthusiasm too much. You really will take home more money in each paycheck. When an increase in income moves you into a higher tax bracket, you only pay the higher tax rate on the part of your income that falls into that bracket. You don’t pay a higher rate on all of your income.
That said, it’s a good idea to see how the extra income from your raise might affect your big picture. You may need to do additional planning to reduce your taxes or retain your eligibility for certain benefits. For example, you might want to either avoid selling investments that have increased in value, especially if you haven’t held them for more than a year, or contribute more to your retirement savings.
Internal Revenue Service. “Rev. Proc. 2021-45,” Page 7.
Internal Revenue Service. "IRS provides tax inflation adjustments for tax year 2023."
Internal Revenue Service. “IRS Provides Tax Inflation Adjustments for Tax Year 2022.”
HealthCare.gov. “How to Save on Your Monthly Insurance Bill with a Premium Tax Credit.”
Internal Revenue Service. “Publication 970: Tax Benefits for Education,” Page 35.
Internal Revenue Service. “Publication 970: Tax Benefits for Education,” Page 24.
Internal Revenue Service. “IRS Issues Frequently Asked Questions to Assist Those Claiming the 2021 Recovery Rebate Credit,” Page 2.
Internal Revenue Service. “Publication 936: Home Mortgage Interest Deduction,” Page 8.
Internal Revenue Service. “Retirement Savings Contributions Credit (Saver’s Credit).”
Social Security. "Cost-of-Living-Adjustment (COLA) Information for 2023."
Internal Revenue Service. “Self-Employment Tax (Social Security and Medicare Taxes).”
Internal Revenue Service. “Questions and Answers for the Additional Medicare Tax.”
Tax Foundation. “State Individual Income Tax Rates and Brackets for 2022.”
Center on Budget and Policy Priorities. “Substantial Income of Wealthy Households Escapes Annual Taxation or Enjoys Special Tax Breaks.”
Congressional Budget Office. “How Taxes and Transfers Affect the Work Incentives of People with Low and Moderate Income.”
Internal Revenue Service. "Administrative, Procedural, and Miscellaneous 2023 Tax Forms and Instructions."
Medicare. “Part B Costs.”
Internal Revenue Service. “Topic No. 559 Net Investment Income Tax.”
Internal Revenue Service. “Rev. Proc. 2021-45,” Pages 6–7.
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