Can Moving into a Higher Tax Bracket Cause Me to Have a Lower Net Income?

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Can Moving into a Higher Tax Bracket Cause Me to Have a Lower Net Income?
Marginal Tax Rates for Taxpayers Filing as Single
Taxable IncomeTax
$0 to $10,27510% of taxable income
$10,275.01 to $41,775$1,027.50 plus 12% of the amount over $10,275
$41,775.01 to $89,075$4,807.50 plus 22% of the amount over $41,775
$89,075.01 to $170,050$15,213.50 plus 24% of the amount over $89,075
$170,050.01 to $215,950$34,647.50 plus 32% of the amount over $170,050
$215,950.01 to $539,900$49,335.50 plus 35% of the amount over $215,950
$539,900.01 or more$162,718 plus 37% of the amount over $539,900

These rates fluctuate depending on whether you file jointly as a married couple, separately as a married couple, or as a widow/widower or head of home.

Here’s an example of how to use the data in this table:

Assume you have $60,000 in taxable income in 2022 and file as an unmarried taxpayer.

  • The first $10,275 is taxed at 10%.
  • The next $31,500 is taxed at 12%.
  • The remaining $18,225 is taxed at 22%.

We used the phrase “a taxable income of $60,000” rather than “a salary of $60,000” or “total compensation of $60,000.” Your true profits might be $72,950. Your taxable income is $60,000 after deducting the standard deduction of $12,950 (for 2022). You owe no federal income tax on the first $12,950 of your earnings.

A More Advanced Example

Now that you’ve grasped the fundamentals of marginal tax rates, let’s expand on the previous example to show what happens to your taxes when you move into a higher tax bracket.

Assume you have a taxable income of $40,000 per year and get a $2,000 increase, bringing your taxable income to $42,000. Because your income did not surpass $41,775, you were previously in the 12% tax bracket. Your highest tax bracket is now 22%. However, at that rate, only $225 of your income ($42,000 – $41,775) would be taxed. The remainder will be taxed at a rate of 12% or less. This is how it works:

  Tax Deed Definition

  • The first $10,275 of taxable income, or $1,027.50, will be taxed at 10%.
  • The following $31,500 in income will be taxed at 12%, or $3,780.
  • Finally, the remaining $225 of your income will be taxed at 22%, or $49.50.

As a result, your total tax will be $4,857. This equates to an overall tax rate of around 12% on the taxable portion of your income. (Because of deductions and credits, your effective tax rate will be lower.)

Now, suppose you hadn’t gotten the $2,000 raise.

Using the same calculations as earlier, your tax bill (on a $40,000 income) would be $4,594.50 (10% $10,275 + 12% $29725).

Bottom line: Your $2,000 raise has increased your taxes by $262.50, but you’re still ahead by $1,737.50.

An Exception to the Rule: Income-Restricted Benefits

Earning more money may actually leave you with less money if it disqualifies you from receiving certain social services, tax credits, or tax deductions. Here are a few such examples:

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

As your marginal tax rate rises, you get to retain less and less of every additional dollar you make. If you have to work more or longer hours to get that additional bucks, there will come a moment when it is no longer worthwhile.

For example, if you’re financially secure, you may not want to work weekends if you’re only getting $76 out of every extra $100 you earn—and that’s before federal income taxes.

Social Security takes an additional 6.2% reduction until you reach the annual Social Security salary maximum ($147,000 in 2022), and Medicare takes an additional 1.45% cut regardless of income.

  9 Sources for Free Tax Help

If you work for yourself, you must additionally pay the employer portion of Social Security and Medicare, generally known as the self-employment tax.

High-income earners must additionally pay an extra 0.9% Medicare tax on earnings over a specified threshold.

Finally, if you make money in a place with high state and local income taxes, such as Connecticut, Hawaii, or New York, you retain even less of it.

You now understand why affluent individuals prefer to reduce their earned income (which is heavily taxed) and increase their investment income (which is generally less taxed)—and why tax experts believe marginal tax rates are a disincentive to work.

Advisor Insight

Clear View Wealth Advisors LLC, Amesbury, Mass., Steve Stanganelli, CFP®, CRPC®, AEP®, CCFSClear View Wealth Advisors LLC, Amesbury, Mass.

A raise may place you in alternative minimum tax (AMT) area, which means you may lose the ability to claim some itemized deductions. The AMT exemption amount for 2022 is $75,900 for single taxpayers and $118,100 for married taxpayers filing jointly.

Furthermore, a little rise in income may result in an increase in Medicare Part B rates two years later. This only affects those who are (or will soon be) 65 or older. Higher Part B premiums begin in 2022 if your modified AGI (modified adjusted gross income, or MAGI) exceeds $91,000 for single taxpayers or $182,000 for married joint filers.

Before converting your Roth IRA, you should consider the tax ramifications, since it may push you into a higher tax rate.

Also, if your 2022 MAGI exceeds $200,000 (single filers) or $250,000 (married filing jointly), you may be subject to a 3.8% net investment income tax (married joint filers).

  How Capital Gains and Dividends Are Taxed Differently

How can I avoid moving into a higher tax bracket?

Timing your income is a common approach for remaining in a lower marginal tax band. If you want to sell any stock that has appreciated in value, you may prefer to do so next year rather than this year if doing so this year will put you in a higher tax bracket and doing so next year would not.

What’s the highest tax bracket?

The highest marginal tax rate on earned income will be 37% in 2022. It is applicable to sums over $539,900 for single taxpayers and $647,850 for married taxpayers filing jointly.

Does my tax bracket affect all of my income?

No. Only a fraction of your income is affected by your tax bracket. As an example, if you are a single taxpayer with taxable income of $50,000, your tax rate would be 10% on the first $10,275, 12% on the following $31,500, and 22% on the remaining $8,225. You will not pay 22% on the whole $50,000.

The Bottom Line

Don’t allow worries about tax rates damper your joy the next time you get a raise. You will really take home more money with each payday. When your income rises, you only pay the higher tax rate on the portion of your income that falls into that higher tax bracket. You do not pay a higher tax rate on all of your earnings.

That so, it’s a good idea to consider how the additional money from your increase may effect your overall financial situation. Additional preparation may be required to decrease your taxes or maintain your eligibility for certain perks. For example, you may want to avoid selling assets that have appreciated in value, particularly if you haven’t held them for more than a year, or you may want to boost your contributions to your retirement savings.

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