Through my 12 years as an accountant and tax advisor, I have found that most people do not fully understand how the federal tax brackets work. Typically people’s perception of how they work is far worse than they actually are. First let’s take a look at the 2012 federal tax brackets.
For purposes of this example, I am going to focus on the Married Filing Jointly tax bracket for 2012, but keep in mind that if you are filing as Single or Married Filing Separately, the tax brackets will reach the same tax rates but at different income levels.
10% $0 – $17,400
15% $17,400 – $70,700
25% $70,700 – $142,000
28% $142,000 – $217,450
33% $217,450 – $388,350
35% $388,350 – on up
The most common misconception about tax brackets is that once you get to the next tax bracket, all of your income is taxed at that rate. For example, people generally think that if their income reaches $217,451, then all of their income will be taxed at 33%. As a result, they are concerned about making more income because they don’t want to fall into the next bracket.
In reality, tax brackets are not that severe. For every Married Filing Jointly tax payer, the income from $17,400 – $70,700 is all taxed at 15%. This does not change, regardless of how much income they earn. The next group of income, from $70,700 to $142,000, is all taxed at 25%. As a result, it is only the dollars that are in the next bracket that get taxed at that rate.
For example, if your taxable income was $218,450, then only $1,000 (the amount over $217,450) would be taxed at 33%. The rest of your income would be taxed at 28%, 25%, 15% and 10%.
It is true that the more income you earn, the higher the overall tax rates will be, but there is no reason to be concerned about making an extra dollar that pushes you into the next tax bracket.