Fear of Federal Income Taxes in Relation To Earning More

I get notes pretty regularly from readers who express concern that earning more won’t actually gain them anything. “Why should I earn more than I’m making if Uncle Sam is just going to take it all?”

That perception is a complete myth. Yes, you will be paying more in taxes if you make more and, yes, you’ll likely be paying a higher percentage of your income in taxes. However, your income will go up far faster than your tax bill will.

In order to keep the picture as clear as possible, I’m going to stick with federal income tax in this example. I’m going to use this calculator to run through a few scenarios.

The Facts On Federal Income Tax Liability

Let’s say that you’re married filing jointly and your gross income is $40,000 per year. You have no investment income, no IRA contributions, two personal exemptions, no dependent children, and you’re taking the standard deduction – in other words, a pretty typical situation for a newly married couple living in an apartment without children.

In that situation, the estimated federal income tax liability will be approximately $2,108. Your average tax rate is 5.3% and your marginal tax rate is 15.0%. You’ll have $37,892 left over.

Now, what happens if you double that income? We can imagine that one person in the family had a job making $40,000 a year, but then the other person gets a $40,000 a year job. What happens then.

Now, you’re married filing jointly and your gross income is $80,000 per year. You have no investment income, no IRA contributions, two personal exemptions, no dependent children, and you’re taking the standard deduction – in other words, the same situation as before, just with more income.

In this situation, the estimated federal income tax liability will be approximately $8,108. Your average tax rate is 10.1% and your marginal tax rate is 15.0%. You’ll have $71,892 left over. That $40,000 bump in income only increases your federal taxes by $6,000.

Of course, I’m leaving out other expenses, such as FICA taxes and state taxes, but the story remains the same – more income means more money for you.

What happens if both people in the marriage find better jobs and double their income? They’ve got to be paying a lot more in taxes now, right?

Now, you’re married filing jointly and your gross income is $160,000 per year. You have no investment income, no IRA contributions, two personal exemptions, no dependent children, and you’re taking the standard deduction – in other words, the same situation as before, just with even more income.

In this situation, the estimated federal income tax liability will be approximately $26,858. Your average tax rate is 16.8% and your marginal tax rate is 25.0%. You’ll have $133,142 left over. That $80,000 bump in income only increases your federal taxes by $18,750.

What if we double it yet again? Surely, the rich must be getting eaten alive by this!

If you’re making $320,000 a year in the scenario described above, your estimated federal income tax liability will be approximately $75,725. Your average tax rate is 23.7% and your marginal tax rate is 33.0%. You’ll have $244,275 left over. That $160,000 bump in income only increases your federal taxes by $48,867.

Here’s the truth: the idea that making more money is pointless because Uncle Sam will take it all is absolutely false. It’s a fantasy that people use as a crutch to excuse themselves from working hard to earn more money.

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