One of my relatives would give away a lot of money — and give away a lot of her labor without pay. This isn't a bad thing by itself, but one of the motivations she had was that she was afraid of being put into a higher tax bracket. It wasn't the only reason, but it was one that she mentioned more than once.
I told her that a little extra income wouldn't give her a huge extra tax bill because of getting bumped into the next tax bracket. The US Federal Income Tax is a progressive tax, meaning that higher earners pay a larger percentage of that income in tax. The tax brackets, though, are called marginal tax brackets. Here are the ones for 2009:
| Marginal Rate | Single | Married Filing Jointly | Married Filing Separately | Head of Household |
| 10% | $0 | $0 | $0 | $0 |
| 15% | $8,350 | $16,700 | $8,350 | $11,950 |
| 25% | $33,950 | $67,900 | $33,950 | $45,500 |
| 28% | $82,250 | $137,050 | $68,525 | $117,450 |
| 33% | $171,550 | $208,850 | $104,425 | $190,200 |
| 35% | $372,950 | $372,950 | $186,475 | $372,950 |
This means that the it's only the portion of income above the threshold amounts that is taxed at the given rate. As an example, if I'm filing singly and had an adjusted gross income (AGI) of $40,000, I'd be in the 25% tax bracket, but my actual tax is far less than 25% of $40,000. It would be $6,187.50, or 15.4% of $40,000. The reason is that only $6,050 of my income (the amount over $33,950) is taxed at 25%.
What could cause a big difference in tax for a small amount of extra earned income is crossing the threshold for the Alternative Minimum Tax. The rules are fairly involved for determining whether this tax applies, but when it does, the tax bill can be substantially higher because a lot of exemptions and deductions are disallowed. This means a jump in the taxpayer's AGI as these exemptions and deductions are added back in, which means a higher tax bill.
In a lot of cases, though, the tax difference in earning an extra few thousand dollars is hardly noticed. So don't let that be an excuse not to earn more. Keep on top of those income streams. 😉
Gosh I hope everyone reads this post. It bothers me to no end that people don’t understand this. I guess I take it for granted because I was a tax professional for 22 years.
But especially during the debate on U.S. Tax policy–people like Joe the Plumber leading the discussion about how he doesn’t want to own his own plumbing business because his taxes will go up!. Yeah, maybe on that little amount that puts him in the highest bracket, if he’s THAT successful. There are worse things in life than being that financially successful.
This misconception is a perfect example of penny-wise and pound foolish.
I agree, this column should be required reading. My husband and I had this same discussion with friends the other day – his friend is afraid of hitting the next tax bracket and wants to refuse a promotion.
Every American should be required to calculate their taxes by hand at least once. I have to do it four times a year for estimated taxes, and using tax tables really drives home the meaning of tax brackets. Tax preparers and tax software have really removed a lot of “common sense” knowledge from our annual tax returns.
Well, now I am worried! This is the last year I get to file Head of Household, under $45,500. Next year, I will be filing single and I make more than the $33,950 limit! I guess it is a good thing that I know this now!