I recently received a question from a reader that we’ll call Frank. Frank is up for a possible promotion, but was told by his boss that the pay increase would push him into a higher tax bracket, and would therefore “not be worth it.” Here are the details:
I work 33 hours/week at $11.40/hour. My boss wants to give me a lead position and a raise of $0.20/hour. However, he then told me he was doing some figuring, and found that the raise would put in in a new tax bracket, and would thus not be worth it. I am single, no dependents. What do you think?
The short answer is that I don’t think Frank’s boss understands how income tax brackets work. Either that, or he’s trying to pull the wool over Frank’s eyes.
Here’s the deal: Income tax brackets reflect your so-called marginal income tax rate. It might help to picture your income falling into separate buckets.
At the low end, you have a 10% bucket. In 2010, the first $8375 of a single individual’s income would fall in that bucket. Next, we have the 15% bucket. The next $25,625 would fall in that bucket (for a total of $34,000). After that, we have 25% bucket, the 28% bucket, the 33% bucket, and the 35% bucket.
(Click through for a full rundown of the 2010 Federal income tax brackets.)
This is, of course, a bit of an oversimplification, as you also need to adjust the numbers for whatever income tax deductions, tax credits, etc. for which you might qualify.
Setting aside that fact that Frank doesn’t actually appear to be near the boundary of any of the current tax brackets, let’s work through a quick example…
Income tax bracket example
Consider a single individual earning $50,000. This puts him in the 25% tax bracket. That does not, however, mean that he pays 25% taxes on his full taxable income. Rather, he pays 10% on the first $8375 (bucket #1), 15% on the next $25,625 (bucket #2) and 25% on the remainder of his income (a partially filled bucket #3). In total, this works out to $8681.25 in taxes, or a “real” rate of roughly 17.4% (ignoring deductions, credits, and other adjustments).
If this individual got a big raise that pushed him into the 28% tax bracket, he wouldn’t lose anything. He’d pay 25% on the balance of bucket #3 (up to $82,400) and then 28% thereafter (until he hit the 33% bracket). As you can see, you have nothing to fear from moving up a tax bracket, and anyone who tells you different is either uninformed or trying to take advantage of you.