That's Not How Tax Brackets Work

One of the comments that I hear most commonly from clients goes something like this: “I don’t want to earn more, because that will push me into a higher tax bracket”.  What this phrase tells me, is that those clients don’t really understand how tax brackets work. 

Hi, I’m Darren from Simmons Capital Group, and today, we are doing some tax bracket myth-busting…

Are there some knock-on effects of earning more money?  Sure there are, on things like Medicare premiums, AMT tax and SS penalties if you are under your full retirement age, but those are beyond the scope of this video.  Today, we will look at how the IRS tax brackets impact you and the total tax that you pay. 

In the US, we have a progressive income tax system. This means that your tax rate increases as your income increases.  There are currently 7 marginal tax brackets, starting at 10% for those married filing jointly earning less than $22,000 per year and up to 37% for those married filing jointly and earning over $693,750 per year.  Here is a chart of the 2023 tax brackets, for a married couple filing jointly:

Here you can see the 7 brackets that I reference, as well as the income ranges that would cause you to progress from one bracket to another. 

That all seems simple enough, but let’s look at where a lot of people go wrong.  To illustrate the confusion that many clients have expressed to me, let’s look at an example together.  For illustration purposes, if someone is currently in the 12% tax bracket, earning $75,000, they might be concerned that if they take a promotion and earn $90,000, for example, that all their money now becomes taxable at 22% versus 12%.  This would obviously offset much of the benefit of getting the raise.  Sure, they would be earning more, but their tax bill would increase so much that they would be in much the same place. In fact, their tax bill would increase from $9,000 per year ($75,000 * 12%) to $19,800 per year ($90,000 * 22%)!

Thankfully, however, this is not how it works.  Just because you might get pushed into a higher tax bracket, does not mean that all your money is now taxed at the higher rate, but rather that just the ‘last’ dollars that you earn. 

To get a better sense of this, let’s look at the last column on the chart that shows actual taxes owed:

In the example of getting a raise and earning $90,000 per year, your first $22,000 is taxed at 10%, the next amount between $22,001 and $89,450 is taxed at 12%, and then the final amount of $90,000 for your salary, minus $89,451 is taxed at 22%.  This results in total taxes of roughly $10,415 which is a lot better than paying $19,800, as assumed if all the money was taxed at 22%!  So yes, you are in a higher tax bracket, but not all your money is taxed at the highest rate.   

Important terms you might come across are the terms marginal and effective tax rates.  In the case above, the investors marginal tax rate is 22%, as their last dollars are taxed at 22%, but their effective tax rate (what they actually pay in tax/total income) is actually much lower, 11.57%.  ($10,415/$90,000).

All this to say, if you get the offer for a raise in pay, don’t say no due to not wanting to get pushed into a higher tax bracket.  Take the job!

If you found today’s topic helpful, please like this video, subscribe and share with friends and family. If you have any questions about your investments, taxes or financial planning, please feel free to book a complimentary meeting with us by calling 518 406 5624 or, visit our website at simmonscapitalgroup.com .

Thanks for watching.