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The Implication on Your Taxes, of a Raise

The Implication on Your Taxes, of a Raise

A lot of people worry that if they get a raise, they will have to pay a higher tax, leaving them in a terrible financial situation. However, it is wrong and a misconception of the income tax system of the federal government that guides the US taxes. Even though salary increase will send you to a higher tax bracket, only the increased impact will be subjected to the rate that increases. 

This article will shed light on the US model of taxation. 


Calculating What you owe in taxes 

Without a doubt, the more money that comes to you as income, the more you will have to release to Uncle Sam. However, the progressively higher tax rate system removes the harsh effect of having extra earnings.  

The marginal tax rate is explained as the tax rate that will be applied to every extra income dollar you earn. A single taxpayer with an annual salary of $39,475 before the raise puts you at the 12% tax bracket (marginal). For 2020, you have a tax liability of $987.50 with 12% of the value of the figure above $9,875. With this, your total debt will be $9,875 with the value of (12% times $29,600) that gives $3,552. This makes your tax for the year 2020 will be $4,539.50. 

Even though you had a 12% marginal tax rate, the average tax that you paid on the earning was lower or reasonable. In getting the effective tax rate, divide your entire tax by the income you earn. For this example, the calculation gives an 11.5% effective tax rate. (4,539.50/39,475).

Assuming there was a $10,000 raise which raised your 2020 annual income to $49,474.99; let us examine the effect on your tax liability for the year. From the previous calculation, you have a debt of $4,539.501, judging by the initial earning of $40,125. Since your entire income is now between the range of $40,125.02 and $85,525.21, the raise shoots you up to the 22% bracket. The good news is that the 22% raise will only be applied to the increased amount - $10,000. This means an additional $2,200 tax and an entire tax bill of $6,743.03.

In estimating your tax rate (overall value), for the new salary of $49,475, all you have to do is divide the total tax you owe ($6,743) by the entire income you had, which gives you the effective tax rate. In this case, it will be $13.6%.


Changes to Expect for 2021 Tax year.

Uncle Sam updates the tax table every year. As a result, for the 2021 tax year, there will be some adjustments to the income value and ranges. The bracket of 12% will apply to income between $9,950 and $40,525. Also, the tax bracket of 22% will apply to payments of 40,525.02 to $86,375.


Credits and Deductions

The example above simply revealed how a salary increment affects tax. It did not account for credits and deductions, which might bring down the taxable income. Taxpayers can decide the best method to file their tax: standard deduction approach or itemized deductions.

There is a significant probability that single taxpayers without a home will not have many deductions that they will itemize on their return. This makes the standard deduction the best approach.

Still, going by our example, the taxpayer will not pay tax on the entire $49,475. Instead, the tax will apply to that amount less the standard deduction value. 

For the 2020 tax year, single filers had their standard deduction value at $12,400, which will bring down this taxable income to $37,275.02. This standard deduction amount was raised to $2,550 for the 2021 tax year.


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THANKS FOR VISITING. 

Karen Munoz, EA
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