WHAT IS 'Incremental Tax'

Incremental tax describes a tax system in which the tax percentage that a person pays increases based on their income level. In an incremental tax system, those with higher incomes pay a larger portion of the taxes collected by the state, and therefore contribute more to a state’s revenue than those with lower incomes.

In an incremental tax system, income levels are sorted into brackets. People often refer to being in a certain tax bracket. Each bracket pays a different percentage of their gross income to the government.

BREAKING DOWN 'Incremental Tax'

Incremental taxes can make a wage increase or profitable investment less profitable than it might seem at first. However, the tax code is structured to make it almost impossible for a person to lose money by creeping into a higher tax bracket.

For example, an  individual may earn $38,000 per year through a salaried job. That income level puts them in a tax bracket that contains individuals who gross between $9,526 and $38,700 per year. In that tax bracket, this person is required by the IRS to pay $952.50 plus 12 percent of any amount over $9,525, which in this case is $3,417. So, $952.50 plus $3,417 equals a total of $4369.50 that this person must pay in taxes.  After paying their taxes, they will have netted $33,630.50

This person may decide that they want to earn some extra money through a second job. If they take on another part-time job and through that job earn an extra $2000 per year, they now fall within a new tax bracket because they earn $40,000. This bracket contains individuals who gross between $38,701 and $82,500. In this bracket, the individual must now pay a tax of $4,453.50 plus 22 percent of the amount over $38,700, which in this case is now $286. The total tax they now owe is $4519.50. After paying taxes, they will have netted $35,260.50. They are still netting more money with a small increase in income, despite being in a new tax bracket.

It is important to note that this example does not account for deductions, including the standard deduction, which also effect the amount of tax that a person pays when filing their tax returns.

Changes in the Tax Code

In late 2017, the U.S. government passed the Tax Cuts and Jobs Act, which included a thorough overhaul of the U.S. tax code. Many aspects of the tax code were changed through this act, including tax brackets and amounts of standard deductions.

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