Have you, or has someone you know, ever uttered the following phrase:
“I was offered a raise, but I turned it down because I would be paying more in taxes than I would be making with the raise!”
Well, I hate to break it to you, but you should have taken the raise. Why? Because of our progressive tax system.
Let’s break it down.
As your income increases, you can find yourself in a new higher tax bracket. What does this mean? Does it mean that all of your income is now taxed at this new higher rate?
Your income is taxed in chunks, each chunk a bracket, so you end up with two tax rates: your marginal rate, the uppermost rate at which your income is taxed, and the effective rate, which is the average rate you’re paying over all. The more income you have in the higher marginal rate, the higher your effective rate will creep up. Wanna find your effective rate? Just divide your total tax liability by your taxable income.
Let’s take a look at how this plays out.
An example goes here
If you’re asking how the capital gain rate plays into all of this, slow down! We have whole posts on that coming soon!
Bottom line: always take the raise.
The TLDR summary:
We all have two tax rates, the marginal rate which is determined by how much taxable income we have, and the effective (or average) rate.