I was talking with a friend about a few ways that he could start earning some more money the other day, and he said something that absolutely stopped me in my tracks: he told me that he didn’t want to earn too much money because it would bump him into the next tax bracket. He was absolutely adamant that he didn’t want to be paying more in taxes.
But, in my mind, a higher tax bracket is a good thing. It’s not something to be avoided. Don’t get me wrong: I’m not quite crazy enough to go out of my way to pay extra taxes, but higher tax brackets are beneficial to your bottom line. Here are five reasons for that simple fact.
1. A higher tax bracket means you have more money.
Do I need to say more? Are there more people out there who think that more money is a bad thing? Our government uses the progressive tax system. That means that the first certain amount of income is not taxed, then the next is taxed at a slightly higher rate, and so on and so forth. Let me use an example with very small numbers to illustrate how a progressive tax system works. Let’s say you earn $50 and that’s taxed at a 10% rate. In this case, your after tax income is $45 because $5 was paid to Uncle Sam. Now let’s say you earn $55 and that bumps you into a 20% marginal tax rate. Yes, you are paying more in taxes now, but the first $50 is still taxed at 10%. It’s only the earnings from $50 on that gets taxed at the higher rate. In our example, You still get the $45 from your first $50 of earnings, plus $4 from the $5 of additional earnings, a total of $54.
In the United States, the higher before tax earnings you make, the more money you can expect in your pocket at the end of the day.
2. A higher tax bracket means more deductions and exemptions.
The average taxpayer isn’t in a position to write off a whole lot on her taxes, which is one of the reasons why the IRS offers the standard deduction. Without the provision, many people would wind up with a higher tax bill. But when you’re earning more money, your deductions, added together, can exceed the standard deduction. For one, many high income earners pay a hefty state tax bill, which is deductible on the Federal tax return.
Many high income earners are also business owners. When you run a business, plenty of business deductions open up. For example, business meals with clients are 50% deductible. While you can’t deduct the expense if you just go out to eat with friends, you certainly saved money if you went out for lunch with a business client since you likely won’t need to eat a second time that afternoon.
3. A higher tax bracket means you can save more.
There are a lot of ways to bring down your tax bill and many of them are good for your overall financial situation. More money means that you are in a position to put away the extra in tax-advantaged accounts for your retirement or your child’s education or for medical expenses, reducing your tax bill. Sure, you may hit limits on certain savings plans, but you probably make quite a bit of money already if you are worried about hitting limits.
4. A higher tax bracket means you can afford a better accountant.
There are plenty of ways to keep your tax bills down, although they require someone very familiar with the tax law. It may not be a bad idea to see a financial planner, as well, but if your only goal is to keep your money out of the hands of the government, an accountant can provide plenty of options.
However, these professionals need to make a living and they can charge quite a good sum for their services. High earners can justify this expense because the same deduction is worth more to them. When you aren’t in a high tax bracket, the deductions an accountant might uncover for you may not save you as much as the fees that are charged. The good news is that you can read up on them yourself no matter how much you make, but having a professional does make things easier.
5. A higher tax bracket means you have more freedom.
If you’re earning enough money that your taxes really are growing by leaps and bounds, you’ve got many options. I wouldn’t suggest moving abroad to somewhere that doesn’t even have taxes, personally, but you can take steps to invest your money and make it grow in such a way that the IRS won’t touch it. You can spend it on purchases that are tax deductible (fixing up your home so it’s more eco-friendly can put you in the way of a few tax breaks). You can donate a big chunk of change to charity. You can even pay your taxes willingly and then go out and spend your money however you like. Earning more money is a fast way to buy yourself some freedom, even if you have to send the IRS a check first.
I know there are plenty of people who look at taxes as one of the biggest burdens of their lives, but if you can change the way you look at your taxes, you’ll eliminate a lot of stress from your life. While I wouldn’t go so far as to say that paying taxes is a badge of honor, I do keep in mind that the money is going to a good cause and that I benefit directly from it. Our tax dollars pay for roads, schools, police forces, and far more, along with helping out people who can’t afford that higher tax bracket. There’s waste in the system, but I like to think that the country is still a lot better with our tax dollars than without.
Don’t be scared of a higher tax bracket, if only because it means that you’re earning more money overall. There are plenty of ways to keep your tax bills to a minimum, but they require you to earn money in the first place. Rather than being afraid of a higher tax bracket, it’s better to be afraid that you’ll wind up in a place where your income is so low you don’t have to pay taxes.
{ read the comments below or add one }
Vtec:
If I make more than you (and I bet I do), I am paying for a higher proportion of the infrastructure, defense and so many other pieces of this nation that you seem to take for granted. Therefore, you are almost certainly stealing from me when you utilize those pieces of America that you take for granted.
Also, next time you power up your smartphone, remember that almost every significant component in (and peripherally used by) that device came from American government invested research, not from private innovation.
A common misconception is moving up a tax bracket can reduce your income because of the high taxes. https://www.google.com/search?q=moving+up+a+tax+bracket&ie=UTF-8&oe=UTF-8&hl=en&client=safari
Your points are true enough but for many who do understand their taxes there are major steps in the system that you want to avoid. When it comes to qualifying for credits, an extra $5,000 can cost $5,000 in credits. The first year I analysed my taxes and started figuring them out – I realized if I’d put x dollars into an IRA it would have been the perfect investment with immediate return and taken all of our tax owed out of the equation. But making more money often takes more time. THAT is the choice often made differently. It’s not worth so much extra time away from family and passions to make the extra money. Live on less than what you make and enjoy every moment.
Only the extra money gets the higher tax. You are correct – many people do not understand that.
All of his advantages are associated with higher wealth, not a higher tax bracket. The tax bracket is associated with higher income, but they aren’t the same thing.
Julie
Almost every tax in existence is marginal so, as has been noted in far more detail than necessary already, moving into the 39.6% tax bracket means nothing for the $352k you earned to make it there. It means only that on your next $100k you’ll be paying $39,600 instead of $35,000. The few people who’d give up $60,400 ($100k-39.6k) to avoid paying the government an additional $4,600 belong to an exclusive club: morons. The real question we should be asking ourselves is: How is it somebody can earn $352,000 and fail utterly to understand anything about how taxes work.
All of this simply supports replacing the current tax code with a VAT or another vastly simplified system. The complicated system we now have primarily exists to cover up loopholes and create accounting jobs.
“Don’t be scared of a higher tax bracket, if only because it means that you’re earning more money overall.”
I vote for moving the tax bracket so that all of us are in the 90% bracket. Imagine how good it will feel for all of us “to be earning more money overall”.
Jason – agree. This whole article assumes, incorrectly, that everyone wants more money… and that making more money is ‘good’…. I thinking “not needing” more money is the better of the two.
If one learns that to be happy with less money, there is sooooo much more freedom in that.
I missed speaking about giving to charity above…. you can give your time – which is usually more precious on a local level than the money.
Deductions? The Standard deduction is now $8400… over half my income 🙂 I’d say that’s more than enough.
Ummmmmm, all 5 of your reasons you gave why being in a higher tax bracket was good were the same… “You make more money” The next 4 were answering the question about why making more money is good…
Right on. If I make 36,000, I keep 30,600…. And if I make 38,000, I only get to keep 27,360. 15 vs 28 percent tax brackets. How is that more money?
Taxes are not only progressive (higher income = higher tax bracket), but also MARGINAL. This means that the higher rate is charged on only income above the next bracket’s threshold. As you appear to have missed several years’ worth of comments, allow me to illustrate with a basic example:
Bracket 1: 10% tax up to $1,000
Bracket 2: 20% tax up to $5,000
1. Let’s say you make $,1000. Your tax is $100 (10% of 1000). Net income = $900.
2. You get a promotion and now make $1,100. According to you, your tax is $220 (20% of 1100). Net income = $880, which is less than before the raise!
3. Let’s look at reality: Income of $1,100. Your tax is $120 (10% of 1000) + (20% of 100). Net income = $980. From your $100 raise, you keep $80.
Did you see what happened? Only income over the threshold was taxed. In other words, you pay the original rate on the first $1000, and only pay the higher rate on anything above $1000 (In this example, $100).
I implore you to look up the meaning of the phrase ‘Marginal Tax Rate’. More gross income means more net income.
I don’t like the idea of paying higher tax rates either, but as pointed out in a few of the comments here, those higher rates only apply to the income that is above a certain amount. To say one doesn’t want to make more money because some of it will be taken in taxes sounds like an excuse for a lack of motivation (although if they started taking 70% like in the 1970s I might lose motivation too).
And 50% is somehow fine, unlike 70%??? Double standard.
Oh.. Thank you very much for the insights. This is really an eye-opener. Now, I don’t need to feel about my taxes. “Money is a tool. It can be used well and poorly.” This is really true, Chris CD.
Good points all the way around. I would point out though that after a certain level of income you actually start losing deductions. However, I don’t sit up at night trying to figure out the “perfect” income level.
Money is a tool. It can be used well and poorly.
That’s an odd way of looking at things, in my opinion.
1. Why is making more money a better thing? It is not how much you make, but how much you DON”T spend… meaning, if you have no need to spend, then why bother with making more???
2. For some in the lower brackets, the standard exemption can be more than 50%… hard to do that with higher brackets… and in order to take a deduction, you have to have spent the money, and then you don’t always get to deduct ALL that you had to spend for the deduction…
3. You MAY be able to save more, but will you??? Rarely does that happen.
Usually, the spending increases even more than the money increased, and you save even less.
4. You can have the same accountant whether you make lots of money or little money… You get what you pay for. Mine is spendy, but his advice is even more important when I need every penny working it’s hardest for me.
5. I had LESS freedom when I was making more as I had to make sure I was at work, etc. Now, making much less, I have all the freedom in the world. Time is way more precious than the money ever was – and I have the option to do what I want. Money itself does not buy freedom – but I will grant that it can buy options that you might have to obtain thru bartering or time spent instead.
If you want something bad enough, there is almost always a way to obtain it without a large capital outlay. You just have to be a bit more creative.
It sounds to me as if your friend may be confusing their tax bracket with their actual tax rate. To use an extreme example for ease of illustration, if one had an AGI of $34,000 in 2010 and is a single filer, one is at the very upper reach of the 15% bracket. That being said, one still does not pay 15% in taxes. That’s because one first pays just 10% on AGI up to $8,375 ($837.50 in this case), and then 15% on the AGI between $8,376 and $34,000 ($3,843.75 in this case), for a total tax of $4,681.75, which is 13.77% of income. If one makes another dollar, one moves into the 25% bracket, but this increases one’s tax liability by $0.25, because one only pays at the higher rate for dollars made above the lower bracket.
Just a thought, but the only “reason” I can see to fear moving up a tax bracket.
I think a lot of people just don’t get how taxes work – I’ve know very smart people who don’t get this and mix up a deduction and a credit, too.
I agree. It’s a very common misconception. I didn’t know until I decided to take a closer look at my taxes. I also remember voicing concerns about being taxed more if I go over a certain bracket to a group of people, and no one corrected me. Now I know there’s nothing wrong with earning more =)
I think you are exactly right that most people dont understand the Marginal Tax Rate in our system of graduated taxes. As you you say, they think that if they earn an extra dollar then that kicks them into the next tax bracket and that they will suddenly pay more in overall taxes… This is of course is not true. A good wiki is here with examples:
http://en.wikipedia.org/wiki/Income_tax_in_the_United_States
From the wiki:
Example of a tax computation
Income tax for year 2009: Single taxpayer, no children, under 65 and not blind, taking standard deduction;
$40,000 gross income – $5,700 standard deduction – $3,650 personal exemption = $30,650 taxable income
$8,350 × 10% = $835.00
$30,650 – $8,350 = $22,300.00
$22,300.00 x 15% = $3,345.00
Total income tax is $835.00 + $3,345.00 = $4180.00 (10.45% effective tax)