The dreaded tax bracket myth! We’ve all heard the silly idea that you’ll somehow lose money on getting a promotion at least once in our lives. This is often peddled by people who don’t quite understand just how our tax system. Specifically, when it comes to how our brackets work.
Well get ready to
annoy impress all of your friends as you smugly inform them on how our tax brackets really work.
Let’s kick this off with the simple, blunt truth. You will not lose money on a raise or promotion if you climb to a higher bracket. Period. Fantastic! Glad that’s settled.
Oh, you wanted more than just that?
Alright, let’s lay out exactly why this is a myth.
Our tax brackets aren’t an all-or-nothing system. Instead, think of it more like a slow moving elevator. We don’t “leap” to the next bracket, rather, it’s a gradual rise to the top. This is why we call our federal income tax system a progressive income tax.
How tax brackets work
Let’s take a quick crash-course on how our taxes really work. This is what the tax brackets look like for a single filer in 2018.
Looking at the diagram above, many people think “oh, I make $37,000, that means I pay 12% in taxes.” This is a common misconception that often isn’t explained very well.
The purpose of these brackets doesn’t mean you pay 12% on all $37,000, then, when you suddenly get a 2% raise, bumps you into paying 22% on all of your money. Instead, we use a much more forgiving system called the marginal tax rate. In other words, what you really pay in taxes.
Think of it this way. If you make $40,000, you’re not paying one flat tax. In reality, you’d be paying 3 different sets of taxes on that money – 10%, 12%, and 22%. I know, it sounds confusing, so we’ll break it down in an example.
Did you know? According to a survey conducted by NerdWallet – over half of Americans aren’t sure what tax bracket they’re in – or even what a tax bracket is!
How marginal taxes work
If you earn $40,000, first you’ll be taxed 10% on all income up to $9,525. Then you’ll pay 12% on the money you earn between $9,526 to $38,700. Finally, you’ll pay 22% on the remaining income above $38,701.
Under the marginal tax system you’d have paid:
- $952 in the 10% bracket
- $3,501 in the 12% bracket
- $286 in the 22% bracket
We’re looking at a grand total of $4,739 in taxes on $40,000. To put it into perspective, a straight flat tax would have you paying 22% of $40k – or $8,800.
That’s the beauty of marginal taxes!
Benefits and welfare
It’s important to keep in mind we’re only talking about income tax brackets. This does not take into account any welfare benefits people might be receiving because they fall under a certain income level.
We understand everyone has their challenges, especially low-income families. That being said, we definitely believe you should never hold yourself back simply to remain on government handouts.
Growing your career will always be a positive experience, even if it makes you take a small step back in the meantime.
It really is as simple as it sounds. You will not lose money from a raise because of tax brackets. While government welfare and medical benefits may come into play, that’s a different matter entirely.
So, the next time you get that sweet promotion, you can look forward to that juicy new check coming in!
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