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On more than one occasion, I’ve received an e-mail asking for advice on how to keep from slipping up into the next tax bracket. The motivation behind such e-mails is typically a misconception of how our progressive tax system works. What many people don’t realize is that our federal income tax brackets reflect marginal rates, not a rate that is applied to your entire income. Here’s a quick example based on current income tax rates…
For a married couple filing jointly in 2008, the 10% tax bracket covers income from $0 to $16, 050. From $16, 050 to $65, 100 the tax rate is 15%. And from $65, 100 to $131, 450 the tax rate is 25%. A couple with a taxable income of $100k will be in the 25% tax bracket, but they won’t have to pay 25% in federal income taxes on the full amount. Rather, they’ll pay just 10% on the first $16, 050, 15% on the next $49, 050, and 25% on the last $34, 900. This works out to $17, 687.50, or an effective rate of just under 18%.
Of course, you should still try to minimize your taxable income as much as possible by contributing to retirement accounts, taking advantage of perks like a flexible spending account (FSA), and maximizing your income tax deductions. But, as you can see from the numbers above, you have nothing to fear from earning a bit more money and finding yourself in a higher tax bracket. Moving to a higher tax bracket will never cause you to take home less money than if your income were lower.