Marginal vs Effective Tax Rate: Why a Raise Never Makes You Take Home Less

A raise never makes you take home less

Suppose your salary rises from $100,000 to $105,000. Federal income tax goes from $13,170 to $14,270, an extra $1,100. That is exactly 22% of the $5,000 raise, the marginal rate, and it is far less than the raise itself.

FICA takes a further 7.65% of the raise, $382.50, so before any state tax you keep about $3,517.50 of the extra $5,000. You are always better off with the raise: the tax is a share of the increase, never more than it.

What happens when you cross a bracket

Now suppose the salary rises from $100,000 to $130,000. Taxable income moves from $83,900 to $113,900, which crosses the $105,700 point where the 24% bracket begins. Only the $8,200 above that point is taxed at 24%; the rest of the raise is still taxed at 22%. Total federal tax is $19,934, an increase of $6,764 on a $30,000 raise, about 22.5%.

That is the whole effect of "moving into a higher bracket": a slightly higher rate on the last slice of income.

Which rate to use for which decision

Use the marginal rate when you are asking what a change in income or deductions is worth:

• A $10,000 traditional 401(k) contribution at $100,000 saves $2,200 of federal tax, 22% of the contribution, because it comes off income taxed at the marginal rate.
• A deduction is worth more the higher your marginal rate, which is why the same deduction saves more for a higher earner.
• A bonus is taxed at your marginal rates, not at some special rate, though your employer's withholding may make it look different on the paycheck.

Use the effective rate when you are asking how heavy your overall tax burden is, or comparing two situations: two people with the same salary in different states, or the same salary before and after a deduction.

Don't forget the other taxes

The table above is federal income tax only. Your real burden also includes FICA and, in most states, state income tax, and each adds to both your marginal and effective rates. At $100,000 in a state with a 5% marginal rate your combined marginal rate on the next dollar is closer to 22% + 5% + 7.65% than to 22%. Our results show the rates for each separately and combined.

See yours

Enter your salary in the calculator to see your marginal and effective rates, then add a deduction or change your state to see how each moves. The Advisory step shows how much more you would need to deduct to drop into the next lower bracket.