Question: As a result of my wife going back to work and me getting a salary increase, we will be making a lot more money in 2023 than 2022. We are concerned that this increase will put us in a higher tax bracket. Because we will be going into a higher tax bracket, will we have to pay more taxes than the increase in income?
Answer: Your question illustrates the confusion regarding the tax rate schedule that I frequently encounter among my clients. It almost ALWAYS makes sense economically to make more money. Only if the tax rates were above 100 percent would it not make sense to earn more money.
Generally, tax preparers look at tax rates from two perspectives, the effective tax rate and the marginal tax rate. The effective tax rate is the total income tax paid divided by your taxable income. The marginal tax rate is the percentage of tax you will pay on the NEXT dollar of income you will earn based upon your current level of taxable income.
The tax rate schedule is “progressive.” The percentage tax rates rise progressively with higher taxable income. However, by earning more, you do not necessarily lose the benefits of the lower tax rate percentage brackets. For example: If you are in the 22 percent bracket and the next dollar you earn will put you in the 24 percent bracket, you will only pay an additional 2 cents (24 cents less 22 cents) on that dollar by entering the 24 percent bracket. Entering the 24 percent bracket does NOT mean that ALL your taxable income will be taxed at 24 percent!
Due to the complexity of the tax laws with many credits and deductions tied to various income levels for phase-outs, there may be certain (but rare) situations whereby earning more money may not be advantageous. Also, you need to make sure that both you and your wife withhold taxes properly from your salaries as your incomes will be combined. If you have a complicated tax return that includes substantial investment income, social security benefits, passive activity losses, education credits, etc., you may want to discuss this issue with your tax return preparer.
Barry Dolowich is a certified public accountant and owner of a full-service accounting and tax practice with offices in Monterey. He can be reached at 831-372-7200. Please address any questions to Barry at PO Box 710 Monterey, CA 93942 or email:[email protected]
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