Starting a side gig, changing jobs, or negotiating a raise at your current position? Raising your income is a powerful way to increase your net worth, but you might be feeling a little worried. What if making more money has unintended consequences?
You may be thinking endlessly about paying more taxes or losing eligibility for certain tax credits. And you might wonder if that raise or side gig will end up costing you more in taxes than it’s worth.
We understand how confusing it can be, especially with all the misinformation and unqualified advice out there. But the bottom line is that you don’t need to be afraid of making more money. Increasing your income is a good thing overall — and even though it might change your taxes a bit, those differences won’t counteract the benefits of a higher salary.
Making more money and tax brackets
Many people worry that raising their income will significantly increase their taxes. But that fear is usually based on a misunderstanding about how tax brackets work. When your income pushes you into a higher tax bracket, you don’t have to pay that higher rate on your entire income — you just pay more on the amount of income that’s in the higher bracket.
For example, let’s say that you are single and you currently make $95,375 in taxable income, which is at the top of the 22% tax bracket (for 2023). You are up for a potential promotion at work that comes with a salary increase. If you get the promotion, you’ll start making $110,000 in taxable income, which will push you into the 24% bracket.
You don’t have to pay 24% on the entire $110,000! Rather, you only pay the higher rate on the amount of money over the bracket threshold. Let’s run the numbers.
If you stayed at your current income, you’d owe $16,290 in taxes for 2023. If you got the promotion, you’d still owe that much on all your income, up to $95,375. You’ll only pay the 24% rate on $14,625, which is the amount of money you made over the $95,375 threshold.
That amount comes out to $3,510, which brings your total tax bill to $19,800. That’s a lot less than $26,400, which is what you’d owe if the 24% tax rate applied to your entire income.
So, if you got the promotion, you’d bring in $14,625 more over the entire year, but you’d only pay $3,510 more in taxes. That’s a significant gain in your net worth!
Subsidies and penalties
Another thing that people are often scared of is a change in the subsidies and tax credits or deductions they may qualify for. This can get a little confusing, but the truth is that you do need a plan for your health insurance — and healthcare subsidies should definitely be considered.
Health care subsidies are generally health coverage that is available at reduced or no cost for people with incomes below certain levels. But if you go over a certain income threshold, will you still qualify? Will you be fined??
It all depends on your individual plan and the state you live in, but there’s good news: Federally, there is a cap on penalties at $600. So even if you no longer qualify for a healthcare subsidy that you’re actively using, you won’t be penalized thousands of dollars.
Important considerations when your income increases
Taxes can be complicated, especially when your income or your job changes. The best way to understand how increasing your income will affect your taxes is to work closely with two financial professionals: a Certified Public Accountant and a Certified Financial Planner™.
A CPA can help you with strategies to minimize your taxes. This type of advice is especially helpful if your new income comes from self-employment (like a side gig). If you have to pay self-employment taxes on your new income, it’s crucial to plan ahead so you can save enough money or make quarterly estimated payments.
And a financial planner can help you figure out the best way to use those new dollars. You might have a lot of options, like paying off debt, contributing more to retirement, saving for college, or paying for some convenience services (like grocery delivery or house cleaning) to make your life easier. A CFP® can help you figure out how to allocate those funds based on your priorities and goals.
Focus on the benefits of higher income
When your income increases, it will impact your taxes, especially if your new salary pushes you into a higher tax bracket. But you won’t pay a significantly higher rate on your whole salary, just the amount over the new tax bracket limit. And it probably won’t have a significant effect on the subsidies and credits you qualify for.
And the easiest way to understand the potential tax consequences is to work with a CPA. They can help you plan ahead and make sure that you’re prepared for tax season.
If you have the chance to increase your income, it’s always a good idea. Just make sure you plan ahead so you use that new money wisely. That could mean updating your budget to give those dollars a job!
Don’t have a budget yet? Check out BudgetingBlocks™, which is our fun, hands-on money management tool. The blocks make it easy to figure out exactly what you want to do with your assets, including extra income from a raise or new job. Find out more about BudgetingBlocks™ here!