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.

Let’s assume in 2024 taxable income It’s $40,000 per year and you get a $10,000 raise, making your taxable income $50,000. Before the increase, your top tax bracket was 12% because your income did not exceed $47,150. Currently your highest tax bracket is 22%. However, only $2,850 ($50,000 – $47,150) of your income will be taxed at this rate. The rest will be taxed at 12% or less. Here’s how it breaks down:

• You will be taxed at 10% on the first $11,600 or $1,160 of your taxable income.
• Then, you’ll be taxed at 12% on the next $35,550, or $4,266, of income.
• Finally, you’ll be taxed at 22% on the remaining $2,850 (or $627) of your income.

So your total tax will be $6,053. This generally works or effectivetax rate 12.1%.

Now, let’s say you don’t get a $10,000 raise.

Using the same math as above, your tax bill on $40,000 in income would be $4,568 (10% × $11,600) + (12% × $28,400).

In conclusion: Your $10,000 increase added $1,485 to your taxes, but you’re still ahead by $8,515 ($10,000 – $1,485).

Exception to the Rule: Income Restricted Benefits

In fact, earning more income may 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 of these items:

Another Consideration: How Much Will You Give Up to Earn Less?

As your marginal tax rate increases, you keep less of each extra dollar you earn. If you have to work harder or longer hours to earn those extra dollars, there will come a point when they are no longer worth it to you.

For example, if you’re financially comfortable you may not want to work weekends if you only keep $76 of every $100 you earn; This only takes into account federal income taxes.

Social Security takes another 6.2% cut until it reaches the annual average Social Security earnings limit ($168,600 in 2024) and Medicare charges another 1.45% no matter your income.

If you are self-employed, you pay the employer share of Social Security and Medicare in addition to the employee share. This is known as: self-employment tax.

High-income earners also pay an additional 0.9% Medicare tax on income exceeding a certain amount.

Finally, if you earn income in a place with high state and local income taxes, such as Connecticut, Hawaii, or New York, then you’re keeping even less.

Now you know why rich people try to minimize their earned income (highly taxed) and maximize their investment income (often less taxed) and why tax analysts say marginal tax rates are a disincentive to work.

In conclusion

Next time you get a raise, don’t let concerns about tax brackets dampen your enthusiasm too much. You’ll actually take home more money with each paycheck.

When an increase in your income moves you into a higher tax bracket, you only pay the higher tax rate on the portion of your income that falls in that bracket. You won’t pay a higher rate on your entire income.

However, it’s a good idea to see how the extra income from your raise might affect your big picture. You may want to do additional planning to reduce your taxes or protect your eligibility for certain benefits.

For example, you may want to 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 qualified retirement savings plan.