Does Getting a Raise Affect Taxes and Your Take-Home Pay?

Receiving a raise is a positive milestone, reflecting personal growth and professional success. However, it also raises questions about its impact on taxes and take-home pay. Understanding how a salary increase interacts with the tax system is essential for managing your finances effectively.

Tax Brackets and Marginal Rates

In the United States, the federal income tax system is progressive, meaning income is taxed at increasing rates as it rises. For 2024, tax brackets range from 10% to 37%, with each bracket applying to a specific income range. A common misconception is that moving into a higher bracket means all income is taxed at that rate. In reality, only the income above the threshold of the previous bracket is taxed at the higher rate.

For example, if your raise increases your income from $89,000 to $95,000, only the $6,000 above the $89,450 threshold (for the 24% bracket in 2024) is taxed at the 24% rate. The rest remains taxed at lower rates. This system ensures that taxpayers benefit from lower rates on their initial income.

If a raise places you near the top of a bracket, consider strategies like increasing retirement contributions to reduce taxable income. This can lower your current tax burden while boosting long-term financial security.

Changes in Tax Withholding

A raise can affect your tax withholding, which is the portion of your paycheck your employer sends to the IRS to cover estimated taxes. Reassessing your withholding after a raise ensures the correct amount is deducted and helps avoid underpaying or overpaying taxes.

The IRS provides Form W-4 to help determine the appropriate withholding amount. Revisiting this form after a raise allows you to adjust for changes in income, deductions, and credits. If your raise significantly increases your income, you might need to adjust the number of allowances claimed to avoid a large tax bill.

Using the IRS Tax Withholding Estimator can provide a precise calculation of your needs. By inputting your new salary and other financial changes, you can determine whether your current withholding is sufficient or requires adjustment.

Social Security and Medicare Taxes

Social Security and Medicare taxes, collectively known as FICA (Federal Insurance Contributions Act) taxes, are calculated as a percentage of your earnings. These taxes differ from federal income taxes.

For 2024, the Social Security tax rate is 6.2% for both employees and employers, applying only to income up to $160,200. If your income surpasses this limit due to a raise, the portion above $160,200 will not be subject to Social Security tax. Medicare taxes apply to all earned income at a rate of 1.45%, with no wage base limit. Additionally, an extra 0.9% Medicare tax applies to income exceeding $200,000 for single filers or $250,000 for married couples filing jointly.

Employers typically adjust payroll systems to reflect these changes, but it’s wise to verify that your paycheck reflects accurate deductions. Self-employed individuals, who pay both the employer and employee portions, face a combined rate of 15.3% for Social Security and Medicare, making careful planning for quarterly estimated payments essential.

Adjustments to Tax Credits

A raise can impact your eligibility for certain tax credits, which directly reduce the amount of tax you owe. Credits like the Earned Income Tax Credit (EITC) or the Child Tax Credit have income limits, and a salary increase could push your income beyond the qualifying threshold, reducing or eliminating the credit.

The EITC, for example, has a gradual phase-out range where the credit decreases as income increases. If your raise places you within this range, you might still benefit from a partial credit. Staying informed about income limits and phase-out thresholds each tax year is critical, as they are subject to annual adjustments by the IRS.

Additional Taxes on Bonuses

Raises often come with bonuses, which are treated differently from regular wages for tax purposes. Classified as supplemental wages, bonuses are subject to specific withholding rules.

Bonuses are generally taxed at a flat withholding rate of 22% for amounts up to $1 million. For example, if you receive a $10,000 bonus, $2,200 will be withheld for federal taxes. Bonuses exceeding $1 million are subject to a higher withholding rate of 37%. While the flat rate simplifies withholding, it may result in overpayment or underpayment of taxes depending on your overall tax situation. If your effective tax rate is lower than 22%, you could receive a refund when filing your return. Conversely, if your total income places you in a higher tax bracket, you might owe additional taxes.

Employers may also use the aggregate method for withholding, which combines the bonus with regular wages to determine the withholding rate. This method can lead to a higher withholding rate if the combined income temporarily pushes you into a higher bracket. Understanding these methods helps you anticipate potential discrepancies and plan accordingly. Consulting a tax professional or using payroll calculators can clarify how your bonus will affect your tax liability.