How Do Tax Brackets Work?

Dear Friend in Finance,

I'm a bit worried. I just got a raise at work, and my co-worker told me that I shouldn't take it. He said that I'd be in a higher tax bracket, and that I'd end up losing money because I'd be paying more taxes. Why are taxes set up like this? It feels impossible to get ahead.

Sincerely,

Taxes are Taxing

Dear Taxes are Taxing,

I completely understand how confusing and frustrating tax brackets can feel. Thankfully, I have great news: this isn’t how tax brackets work!

In the U.S., we use marginal tax brackets. This means higher tax rates only apply to the portion of your income within that specific bracket—not your entire income.

Think of it like filling a series of buckets, each representing a tax bracket (e.g., 10%, 12%, 22%, 24%, etc.). Your income is like water that you pour into these buckets:

1. You fill the 10% bucket first. Once it’s full, you move to the 12% bucket.
2. When that’s full, you start pouring into the 22% bucket, and so on.
3. If you only have a small amount of water left when you start filling the 22% bucket, only that small amount is taxed at 22%. The rest in the other buckets is taxed at their lower rates.

This means entering a higher tax bracket won’t suddenly apply the higher rate to all your income—just the dollars that spill into that bracket.

If you’re concerned about minimizing taxes, a financial planner or tax professional can help you explore strategies like contributing to retirement accounts or using other deductions to reduce your taxable income. But the key takeaway is this: you won’t lose money by moving into a higher tax bracket.

I hope this clears things up for you!

Sincerely,

Your Friend in Finance