There’s a persistent tax myth that worries many: the fear that earning a bit more could push you into a higher tax bracket and trigger a hefty tax on your entire income. This idea—that a raise or bonus might leave you with less take-home pay—is understandable but untrue.

The U.S. uses a progressive tax system, where different portions of your income are taxed at different rates. Moving into a higher tax bracket only affects the income within that bracket, not your entire earnings. Instead, each “marginal” tax rate applies in layers to specific portions of your income.

But while earning more won’t reduce your take-home pay overall, it can still lead to unexpected financial impacts because a higher income can result in your crossing certain thresholds that reduce or eliminate your eligibility for various tax deductions, credits, and other benefits.

It’s important to understand that these thresholds are tied to your income level—not your tax bracket. As such, even a relatively small increase in income can have disproportionately negative consequences. Let’s examine how these factors affect your tax picture, starting with an overview of marginal versus effective tax rates. We’ll then explore strategies to help you manage these thresholds and avoid any extra costs from earning a bit more.

How Marginal and Effective Tax Rates Work

To truly understand tax brackets, it’s important to distinguish between marginal and effective tax rates. While the term “marginal tax rate” refers to the rate applied to the last dollar you earn, the “effective tax rate” is the average rate you actually pay across all your income. You can think of each tax bracket as a set of buckets you’re filling with income. The first bucket has a lower tax rate, and once it’s filled, any extra income spills into the next bucket, which has a slightly higher rate. Only the amount in each bucket is taxed at that particular rate, and as your income grows, you simply move into new buckets.

For 2024, there are seven federal tax brackets: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. Each of these brackets applies to a specific portion of your taxable income, depending on your filing status. Let’s use an example to illustrate how these rates work in practice.

Suppose you earn $60,000 in taxable income. The first portion of your income falls into the lowest tax bracket, which is taxed at 10%. Once that bracket is filled, the next portion is taxed at 12%, and so on. Only the income that falls within each bracket is taxed at that rate, meaning your highest marginal rate isn’t applied to all your earnings.

Let’s break it down:

• 10% on the first $11,600 = $1,160
• 12% on the portion between $11,601 and $47,150 = $4,266
• 22% on the portion between $47,151 and $60,000 = $2,823

Your total tax bill would be $8,253, but note that only the income above each threshold is taxed at the higher rate.

Your effective tax rate, on the other hand, is the overall percentage of your income that goes to taxes. It’s calculated by dividing your total tax owed by your total taxable income. In this example, although your highest marginal tax rate is 22%, your effective tax rate is lower because different portions of your income are taxed at different rates.

Using the $60,000 example:

• Total taxes owed: $8,253.90
• Total taxable income: $60,000
• Effective tax rate = $8,253.90 / $60,000 = approximately 13.76%

Why Earning More Still Matters

Now that we’ve dispelled the myth that higher tax brackets raise the tax rate on your entire income, it’s time to examine why even small income increases can still impact your overall financial outcome. The tax code includes phaseouts, thresholds, and income-based rules that reduce eligibility for certain credits, deductions, or benefits—or even trigger additional taxes. These effects don’t just apply to high-income earners; they also impact mid- and low-income earners, who may encounter “benefits cliffs” with public assistance programs. Let’s look at how income changes can have financial implications for a range of taxpayers.

Phaseouts for Credits and Benefits: Phaseouts refer to the gradual reduction of tax benefits—such as deductions, credits, or exclusions—once your income surpasses specific limits. As your adjusted gross income (AGI) increases, certain benefits may phase out, resulting in reduced tax savings or eligibility:

• Roth IRA Contributions: For higher-income taxpayers, phaseouts impact deductions and retirement benefits. For example, if you and your spouse file jointly with an income of $230,000, you may still qualify to contribute to a Roth IRA, a retirement account with significant tax advantages. However, if your income rises to $240,000 or above, you could lose eligibility entirely, missing out on valuable retirement savings.
• Earned Income Tax Credit (EITC) and Child Tax Credit (CTC): For mid- and low-income taxpayers, phaseouts can impact tax credits like the EITC and CTC. The Child Tax Credit phaseout begins at $200,000 for single filers and $400,000 for married couples filing jointly, which primarily affects middle- to higher-income taxpayers.

Additional Taxes/Higher Rates: Exceeding certain income thresholds can trigger additional taxes, or higher rates applied in some instances:   

• The Medicare Surtax: Higher-income earners may face an additional 0.9% Medicare surtax on wages, self-employment income, and compensation above $200,000 for single filers ($250,000 for married filing jointly). For instance, a family with a combined income of $255,000 would pay an additional 0.9% Medicare surtax on the $5,000 that exceeds this threshold. While the amount may seem small, these added taxes can accumulate as income grows.
• The Net Investment Income Tax (NIIT): This 3.8% surtax applies to net investment income for individuals with Modified Adjusted Gross Income (MAGI) above $200,000 for single filers ($250,000 for married filing jointly). The NIIT affects income from sources like interest, dividends, capital gains, rental income, and other passive investments, adding an additional layer of taxation for higher earners.
• High-Income Threshold for Capital Gains: Capital gains and qualified dividends are generally taxed at preferential rates (0%, 15%, or 20%), depending on your income level. For high-income earners with taxable income exceeding $553,850 for married filing jointly in 2024, the rate on long-term capital gains increases to 20%. This means that as your income rises, you may be subject to higher tax rates on gains from investments.

Unexpected Loss of Benefits/Public Assistance: Public assistance recipients at lower income levels may encounter “benefits cliffs,” where even a small income increase could result in a complete loss of eligibility for multiple support programs. Here are some of the most significant benefits cliffs that individuals may face:

• Medicaid Eligibility: Medicaid provides essential health coverage for low-income individuals and families. However, if your income rises even slightly above the eligibility threshold, you could lose access to Medicaid entirely. This loss can be particularly challenging, as health insurance alternatives may be unaffordable or unavailable, leaving a gap in coverage.
• Supplemental Nutrition Assistance Program (SNAP): SNAP, commonly known as food stamps, offers nutrition assistance to low-income households. An increase in income may disqualify a family from SNAP benefits, leaving them with significantly higher grocery costs without the safety net they once relied on.
• Housing Assistance (Section 8): Section 8 housing assistance helps cover rent for eligible low-income households. When income exceeds certain limits, families can lose this critical support, forcing them to cover the full cost of rent, which can be a significant financial burden—often outpacing the value of the income increase.
• Child Care Subsidies: Many states offer child care subsidies to help low-income parents afford daycare or child care services. Even a modest increase in income can lead to a loss of this assistance, making child care costs unaffordable and potentially forcing parents out of the workforce.
• Healthcare Subsidies (ACA): Under the Affordable Care Act, individuals earning above 400% of the federal poverty level were previously ineligible for health insurance subsidies. However, recent legislation, including the American Rescue Plan Act, has expanded subsidy eligibility, allowing individuals above this threshold to receive some level of assistance. It is important to verify the current rules to determine eligibility.
• Supplemental Security Income (SSI): SSI provides cash benefits to individuals with disabilities who have low income and limited resources. A slight increase in income can lead to a reduction or complete loss of SSI benefits, impacting not only the direct financial assistance but also eligibility for associated programs like Medicaid.
• Special Supplemental Nutrition Program for Women, Infants, and Children (WIC): WIC provides nutritional support for pregnant women, new mothers, and young children. A small increase in family income can result in losing WIC eligibility, which affects access to nutritious food and critical health support for those who need it most.

These benefits cliffs can create situations where a modest increase in earnings results in a net financial loss due to the withdrawal of valuable support programs. For many low-income individuals and families, the prospect of losing these essential benefits discourages efforts to increase income, as the financial repercussions can outweigh the additional earnings.

Tax Management Strategies to Avoid Unwanted Results

After exploring the basics of marginal and effective tax rates and why income levels matter for phaseouts and thresholds, let’s shift to strategies that can help you sidestep some of the unintended consequences of a higher taxable income.

• Maximize Retirement Contributions: You can lower your AGI by contributing to tax-advantaged retirement accounts, such as 401(k)s, traditional IRAs, or 403(b)s. Because these contributions are typically tax-deductible, they can help you stay within a lower tax bracket or retain eligibility for certain credits, such as the Saver’s Credit or the Child Tax Credit. For 2024, the contribution limit for 401(k) plans is $23,000, with an additional $7,500 catch-up contribution allowed for individuals aged 50 and older. For traditional IRAs, the contribution limit is $7,000, with an extra $1,000 catch-up contribution for those aged 50 and older.
• Use the Saver’s Credit (if Eligible): Low- and moderate-income taxpayers who contribute to retirement accounts may qualify for the Saver’s Credit, a valuable credit that can directly reduce the tax they owe. This is especially helpful for those working to grow retirement savings on a limited income. In 2024, the Saver’s Credit is available for taxpayers with an AGI of up to $36,500 (single) or $73,000 (married filing jointly).
• Harvest Capital Losses: If you have investments that have lost value, consider selling them to offset gains in other investments and reduce taxable capital gains (a practice referred to as tax-loss harvesting). Furthermore, you can also use up to $3,000 of yearly losses to offset other income.
• Deferring Capital Gains: If you expect to be in a lower tax bracket in the future, consider deferring the sale of investments that would trigger capital gains. This allows you to pay a potentially lower tax rate on your gains in a future year or to benefit from long-term capital gains rates, which are generally lower than short-term rates.
• Investing in Tax-optimized Funds: Exchange-traded funds (ETFs) and index funds usually have lower turnover rates than actively managed mutual funds, creating fewer taxable events and, therefore, reducing your taxable gains.
• Managing the Timing of Your Income: If your income fluctuates, or you can control the timing of your income, consider timing your income or deductions strategically. For example, if a year-end bonus would push your income over a threshold, you might ask to defer it to January to stay within certain limits. Alternatively, if you can control expenses—such as business expenses or retirement contributions—accelerating them into the current year may help lower your AGI.
• Make Charitable Contributions: Charitable donations can help reduce taxable income, especially if you itemize deductions. Using a donor-advised fund (DAF) allows you to make a charitable contribution, take an immediate tax deduction, and recommend grants over time. This approach is particularly helpful in high-income years, allowing you to “front-load” your giving for a significant deduction.

Tip: While this strategy is often more practical for high-income earners, low- to mid-income taxpayers who itemize their deductions may also benefit. Keep in mind that donating doesn’t result in more money than if you hadn’t donated—it simply reduces the cost of giving through tax savings.