Getting a Big Raise at Work? Prepare for This Tax Surprise

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  • A giant raise at work could improve your financial picture.
  • It could also come with some sneaky tax consequences.
  • A significant increase to your income could place you in a higher tax bracket.

You don't want to get caught off guard.

Congratulations! After months (or maybe years) of hard work, you've finally managed to snag a large raise at work.

Having more money in your paycheck could work wonders for your finances. Not only might it help you manage your bills with less stress, but it could also be your ticket to meeting different financial goals, whether it's building savings, paying down debt, or purchasing a home.

But if your income is going up substantially, that could impact the amount of tax you end up owing the IRS. And it's important to understand the tax-related implications before you go off spending your extra money.

Related:Best Tax Software

Prepare to land in a higher tax bracket

The U.S. tax system is a marginal one, which means you pay a higher rate of tax on your highest dollars of earnings. That tax rate, however, doesn't necessarily only apply to your income from a job.

If you have money in a savings account, for example, the interest you earn is taxed as ordinary income. And so the higher your tax bracket, the more of that interest income you'll owe in tax form.

Here's a snapshot of what 2022 tax brackets look like:

Tax Rate For Single Filers For Married Individuals Filing Joint Returns For Heads of Households
10% $0 to $10,275 $0 to $20,550 $0 to $14,650
12% $10,275 to $41,775 $20,550 to $83,550 $14,650 to $55,900
22% $41,775 to $89,075 $83,550 to $178,150 $55,900 to $89,050
24% $89,075 to $170,050 $178,150 to $340,100 $89,050 to $170,050
32% $170,050 to $215,950 $340,100 to $431,900 $170,050 to $215,950
35% $215,950 to $539,900 $431,900 to $647,850 $215,950 to $539,900
37% $539,900 or more $647,850 or more $539,900 or more
Source: TaxFoundation

So here's how a big raise might impact your tax situation. Let's say you're single and your pre-raise salary is $40,000. Assuming that's your sole income source, that means you fall into the 12% tax bracket, and so your highest dollars of earnings (not all of your earnings) are taxed at 12%.

If you get a raise that increases your salary to $60,000, you'll land in the 22% tax bracket. That means your highest dollars of earnings will now be taxed at 22%.

But remember, that doesn't just mean you should expect higher taxes on part of your salary. That tax rate will also apply in other situations, such as if you earn interest in a savings account.

Similarly, if you have investments in a brokerage account that you sell before having held them for at least a year and a day, any profits you make will be subject to short-term capital gains taxes. The tax rates there mimic the tax brackets above. So in your case, you'd potentially be looking at paying a 22% tax rate on short-term capital gains instead of the 12% you might've been subject to at a lower income level.

Know what to expect

Being taxed at a higher rate is not a good reason to avoid pursuing a raise. You should still aim to increase your income as much as possible throughout your career. The point, rather, is to be aware of what higher pay might mean in terms of your tax situation.

And also, if you're getting a raise, don't spend a dime of it until you actually get your first paycheck and see how much it goes up by. You may not get as much money in your pocket as expected because of your new tax bracket, so before you make any purchases, see what amount of extra cash you're actually looking at.

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