Some people worry that winning a raise catapults them into a higher tax bracket. But this is a somewhat misguided notion about how the progressive federal income tax system works. While those who receive salary boosts are indeed taxed at higher rates, only the added income is vulnerable to increased rates. This article explains how the taxation model truly works.
How to Calculate How Much Tax You Owe
It's a fact: the more you earn, the more taxes you must pay. But the progressively higher tax rate takes some of the sting from pulling in more cash. The tables below show the tax rates the IRS required you to pay on your 2019 income if you were single or married filing jointly.
Your marginal tax rate is the rate of tax that applies to each additional dollar of income earned. If you're single and earned $39,475 a year before your raise, you were in the 12% marginal tax bracket. Your tax liability was $970 plus 12% of the amount over $9,700. The amount you earned over $9,700 was $29,775, so you owe $3,573 in tax on $29,775 and $970 in tax on $9,700 for a total of $4,543 in tax. While your marginal tax rate was 12%, your effective tax rate, or the average rate of tax you paid on your total income, was lower. To calculate your effective tax rate, divide your total tax by your total income. In this case, $4,543/$39,475 gives you an effective tax rate of 11.5%. (For more, check out How Your Tax Rate Is Determined.)
Now, let's examine what happens to your tax liability if you win a $10,000 raise that elevates your annual income to $49,475. You already know that you owe $4,543 on the first $39,475 you earned. But now that your total income falls between $39,475 and $84,200, your $10,000 raise bumps you into the 22% tax bracket. Fortunately, that 22% rate only applies to your $10,000 additional income, where you would owe an extra $2,200 a year in tax, for a total of $6,743 ($4,543 + $2,200).
To determine your overall tax rate for your $49,475 salary, simply divide $49,475 by your total tax ($6,743), to reveal an effective tax rate of 13.6%, not 22%.
Deductions and Credits
The aforementioned example doesn't account for the deductions and credits that may potentially reduce your taxable income. Simply put: every taxpayer chooses whether to take a standard deduction or to itemize deductions. Single individuals who don't own a home, probably don't have many deductions to itemize, so a standard deduction makes greater sense. Instead of paying tax on all $49,475 that you earn, you'll pay tax on that amount minus the standard deduction. In 2019, the standard deduction for single filers was $12,200, reducing taxable income to $37,275.
The Bottom Line
The progressive tax system lets individuals pay different amounts of tax on different portions of their income, where only the additional income is subject to increased rates. Consequently, a raise is a cause for celebration, and not a source of angst.