Your marginal tax rate applies only to the top slice of your income, and lower rates cover everything beneath it. Use that marginal rate to judge a raise, a deduction, or a 401(k) contribution, and never turn down extra income to stay out of a higher bracket.
The federal income tax works in layers. The first chunk of your taxable income is taxed at 10%, the next at 12%, then 22%, and so on up to 37%.
Each rate applies only to the dollars inside its own layer. So crossing into a higher bracket changes the rate on the dollars past the line and nothing else. Say a $5,000 raise carries you $1,000 past the top of the 12% bracket. The first $4,000 of it is taxed at 12% and the last $1,000 at 22%, so you keep $4,300 of the raise before payroll and state taxes. A raise can’t shrink your take-home pay by moving you into a higher bracket.
Your average rate, the share of your income that actually goes to federal income tax, sits below your top bracket once your income spans more than one layer. The standard deduction pulls it lower still, because that slice of income is never taxed at all. To find yours, divide the total tax on last year’s return by your total income.
Each number has its own job. Your marginal rate is the tax rate on your next dollar. In the 22% bracket, a $1,000 pre-tax 401(k) contribution, or a $1,000 deduction if you itemize, cuts your federal income tax by $220, and $1,000 of extra pay leaves you $780 before payroll and state taxes. A tax credit works differently. It subtracts from the tax itself, so a dollar of credit cuts a dollar of tax whatever your bracket.
Turning down overtime, a bonus, or a side gig to stay in a lower bracket never pays off on income tax. The extra dollars are taxed at the higher rate, and every dollar beneath them is taxed exactly as before.
Budget with your average rate, and decide with your marginal rate. Before you pass on extra income or skip a deduction, run the math on the next dollar alone.
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