Confused About Marginal Tax Rates? You're Not Alone

August 20, 2008

In a recent article on CNN.com, Career Builder provides information regarding the "dangers" of a larger paycheck. The article assumes a pay raise may place a worker in a higher marginal tax bracket, resulting in lower take-home pay. Have no fear; a pay raise will not result in lower net earnings.

From the CNN/Career Builder article:

Potential backfire No. 2: The more money you make, the more money you lose

Let's say you earn $85,000 annually and you received a raise that brought you up to $90,000. Sounds exciting at first -- until you the do the math and realize your new check is only a couple hundred dollars more than your old one.

One of the negatives to earning a high salary is that your marginal tax rate is higher than other people's. While you might be earning more than your co-worker, he or she might be taking home a similar -- or higher -- amount per check because they aren't taxed as much.

Income taxes are complicated, but using the CNN example may clear things up. Calculating the federal income tax burden requires a few steps. Each taxpayer is charged different rates on different levels of their income. A taxable income of $90,000 falls into the 28% marginal tax bracket for a single filer. The worker pays 10% on the first $7,825 earned, then increasing percentages on the income made within each bracket. A simple calculation using the tax table below yields the following tax bill:

Taxable income = $85,000
Income tax = $15,698.75 +$2,212 (28% of the amount over $77,100)
Income tax = $17,910.75
Take-home pay = $67,089.25 (effective tax rate of 21.07%)

Taxable income = $90,000
Income tax = $15,698.75 +$3,612 (28% of the amount over $77,100)
Income tax = $19,310.75
Take-home pay = $70,689.25 (effective tax rate of 21.46%)

Effective tax rates measure the tax bill as a percentage of taxable income. This employee's effective rate increases, meaning more income went towards taxes, but their net pay certainly increases as well.

If taxable income is over--

But not over--

The tax is:

$0

$7,825

10% of the amount over $0

$7,825

$31,850

$782.50 plus 15% of the amount over 7,825

$31,850

$77,100

$4,386.25 plus 25% of the amount over 31,850

$77,100

$160,850

$15,698.75 plus 28% of the amount over 77,100

$160,850

$349,700

$39,148.75 plus 33% of the amount over 160,850

$349,700

no limit

$101,469.25 plus 35% of the amount over 349,700

Making less money is not advantageous under the marginal tax bracket system.

See the different income tax brackets here.

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