Will Moving Into a Higher Tax Bracket Give Me a Lower Net Income?

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.

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).

Note: These rates are different if you file your taxes as a married couple, if you’re married but file separately, or if you qualify as a widow/widower or head of household.

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
• Medicaid
• Student loan interest deduction
• Lifetime Learning Credit
• 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.

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

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.

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.