As an individual earning income, it is essential to understand how tax brackets can impact your take-home income. Tax brackets refer to the different levels of income, with each level being taxed at a different rate. The tax bracket you fall into will determine how much tax you owe and can have a significant impact on the amount of money you take home.
The federal government and most states have a progressive tax system, which means that the more you earn, the higher your tax rate. Tax brackets are typically split into five or six different levels, with the lowest level having the lowest tax rate and the highest level having the highest tax rate.
For example, let’s say your taxable income is $50,000, and you live in a state with a six-bracket tax system. In the first bracket, your income would be taxed at a rate of 1%. If you earn $10,000, only $100 out of that money would go towards taxes. In the second bracket, the rate may be 3%, and in the third bracket, it could jump to 5%. The fourth bracket could be 7%, and the fifth could be 9%. The highest tax bracket would be 11%.
If your income falls into the fourth bracket with a 7% tax rate, you would owe $3,500 in taxes on that income alone. That means that after taxes, you would only take home $46,500, rather than the full $50,000.
One aspect to note is that only the income falling into each bracket is taxed at the corresponding rate, not the entire income amount. Using the example above, the first $10,000 of your income would only be taxed at the 1% rate, while the remaining $40,000 in taxable income would be taxed at various rates across the additional brackets.
Tax brackets do not only affect your take-home income, but they can also provide incentives to increase your income, as long as it falls under a lower tax bracket. For example, if you earned $42,000 and received a $5,000 raise, you may want to consider negotiating a lower salary increase to mitigate crossing into a higher tax bracket of 22% and instead take a smaller pay bump that keeps you in the 12% bracket.
Knowing your tax bracket can help you plan your finances and ensure you’re not blindsided come tax season. It is also necessary to note that different tax brackets apply to different types of income, like capital gains or self-employment income. Your understanding of these brackets can play an instrumental part in mitigating your tax risk and taking home the most of what you earn.
