Have you ever heard someone say “I don’t want that raise since I’ll be in a higher tax bracket, and will end up making less money after taxes”? But is that true? Should you decline a small raise? Heck no!! Thanks to our progressive tax system, on the federal level and for many states, if you get a raise that elevates you into the next tax bracket, the progressive tax system saves you from losing money on a raise.
But what does this mean? Okay, so imagine this: you get a raise from $50,000 to $60,000. A huge job, especially in corporate America, congrats! But then you start thinking, shoot, this means I’ll move from the 12% federal tax rate all the way to the 22% federal tax rate. Almost double the tax rate, even though you only got a 20% raise! But here’s where the progressive tax system steps in to help out. To do a little math here, at a salary of $50,000, your taxable income is actually $37,050 thanks to the usual standard deduction (assuming you don’t have any other deductions or credits). However, of this $37,050, $10,275 of it is taxed in the lowest tax bracket, at 10%, for $1,027.50 in federal taxes. And per the IRS tax brackets, all income between $10,276 and $41,775 is taxed at 12%. Now a big difference there, this results in the remaining $26,775 of your taxable income being taxed at 12%, resulting in a bill to the IRS of $3,213. Already a lot, right? A total of $4,240.50 out of your paycheck. But this could be more! If you were taxed at 12% for all of that income, you’d pay $4,446, over $200 extra!
But anyways, on to the question at hand: why does the progressive tax system help with raises? To continue with the same numbers, you would end up with $47,050 in taxable income after the standard deduction on a $60,000 salary. So now, you worry about jumping all the way up to the 22% tax bracket!! A scary big jump from 12%. But remember, only taxable income above $41,775 is taxed at that rate! So of that $10,000 raise, the first $4,725 is still taxed at 12%. So after adding that income tax of $567 to the original amount of $4,240.50 leaves you with a total tax of $4,807.50. But now you’ve gotta add the remaining $5,275 of your raise. This will be taxed at the higher rate of 22%. So that comes out to $1,160.50, nearly a quarter of your previous total for such a small income! With the progressive tax rate, your federal taxes come out to be $5,968. And how much money does your raise actually make you after federal taxes? You would end up with $8,272.50 after a total federal tax of $1,727.5 on the raise, so still pretty awesome! So make sure to take that raise!
Of course, all of this doesn’t include state taxes or FICA (social security and Medicare), so you’ll want to know what those would be, leaving you with even less, but still a positive. The main point is that you should always take any pay raise you can get, since the progressive tax system on a federal level (and many states’ levels) allows you to bring home more money, even if that certain amount you got with the raise is taxed at a higher level.