How Getting a Raise Affects Your Taxes
Getting a raise is a big deal for your career and for your wallet! Before you start spending that hard earned “extra” money, think for a moment about the potential implications on your tax return. Fortunately, despite what many think or assume, you will not automatically be bumped into a higher tax bracket and lose all the extra profit that comes in, but it is helpful to plan for the impact a raise will have on your taxes.
It is true that the more money you make, the more money you pay in taxes. So how do you figure out exactly how much will be deducted from your new paycheck? We’ve broken it down for you so that you can figure out how much will stay in your pocket and how much will go to the IRS.
There are a couple of tax terms to familiarize yourself with so that this will makes sense:
- Progressive Tax System: A tax system in which the tax rate increases as the taxable base amount increases. The U.S. tax system is progressive.
- Marginal Tax Rate: This term refers to the rate of tax that applies to each additional dollar of income a taxpayer earns. Here is an example of how a marginal tax rate works: Your current salary is $34,500 a year (before your raise), which puts you in the 15% marginal tax bracket. Based on this, the IRS will require you to pay $850 plus 15% of the amount you make over $8,500. The amount over $8,500 you make is $26,000, so you owe the IRS $850 plus $3,900 for a total of $4,750.
- Effective Tax Rate: In the example above, your marginal tax rate was 15%, but the average rate of tax you paid on your overall income is less (13.8%). This average rate of tax you pay is the effective tax rate.
How does this apply to your raise?
So, let’s add in your raise. What if you get a (large) $10,000 raise? Your new salary will go from $34,500 to $44,500. How much more will you pay in taxes? You already know how much you will pay for the first $34,500 you make. All you have to figure out now is how much you will pay on the additional $10,000. Since your total income now bumps you up into a different tax bracket ($34,500-$83,600), you will have to pay a marginal tax rate of 25% only on the additional $10,000. You will owe $2,500 on the $10,000, bringing your grand total to $7,250. That brings your effective tax rate up from 13.8% to 16.3%, still much lower than the 25%.
“Take Home” Message
So, while you may not love paying a bit more on the raise that you get, you will still take home a significant amount of it. This calculation might seem complicated, but the IRS website has information about your tax rate based on your income. You can also use this raise as an opportunity to take a full view of your taxes, including potential deductions and credits.
If you find yourself in a messy situation with your taxes or don’t understand how this works, give Success Tax Relief a call toll free at 877-825-1179.