Dispelling the Income Tax Bracket Myth

One of the more notorious myths associated with tax season is that by earning more money in a tax year an individual could get pushed into a "higher tax bracket" and thus earn less money.  This simply isn't the case with a progressive tax system.  There are scenarios where an individual can end up paying more in taxes over multiple years, but we'll explain one simple trick to help minimize the total amount an individual has to pay.

Income Tax in the United States:

For the sake of keeping Ulmer Scientific a blog and not a book, we examine raw income tax only (exclusive of any credits, dividends, capital gains, etc.) for the single filer.

The United States uses a marginal tax rate to generate an average progressive, or effective tax rate, on one's income.  Plotting this rate against income generates this neat bunny-hop chart:

 Take special note of the tax bracket ranges and resulting effective tax rate.  Because of the marginal way taxes are calculated, individuals in the 28% tax bracket actually pay almost 3 percentage points less in total tax.  In theory, individuals could earn an infinite amount of income, and never fully pay the maximum rate of 35.6%.

Okay, so effective tax rates are cool, but most individuals would just like to know what that means in dollars.  Below are the total income tax owed and resulting take home pay for 95% (<$100,000/yr) of Americans:

2013 Estimated Tax & Take-Home Income for Single Filers

Notice the plot for Take Home Income After Tax never goes down as income increases.  In no way could earning more money in a year result in an individual taking home less money.

Now, fear of the "next tax bracket" isn't completely misplaced, income in the next bracket is taxed at a higher rate.  Having one's income break into the next bracket is never a bad thing, however if it can be avoided there is a way to save more and pay less in the long run.

The Trick:

To pay the least amount in total tax, earn the lowest average income over multiple years.

For example, say Sally Smith knows she'll earn $24k this year, $34k next year, and $44k the next year.  If she has a $10k bonus, it would be wisest to take it this year.  Taking it next year would result her in bonus being taxed at a higher rate ($775 more).  Taking it the third year would force a loss of an additional $225!

In conclusion, its not possible to earn less money in a year by crossing into the next tax bracket (Myth Busted); albeit, if an individual has a varying income, it makes sense to spread that income evenly over multiple years.