The marginal system
Federal income tax uses a marginal rate system. “Marginal” means the tax rate applies at the margin, to each additional dollar earned, not to all income.
This distinction matters because many people believe entering a higher tax bracket means all their income gets taxed at the higher rate. They imagine a raise pushing them into a higher bracket could result in less take-home pay. This never happens.
Each tax bracket is a bucket that fills before the next one starts. The first bucket of income gets taxed at the lowest rate. When that bucket fills, additional income spills into the next bucket at the next rate. Income in the first bucket doesn’t get re-taxed at the higher rate; it stays taxed at the lower rate.
2025 tax brackets in practice
For a single filer in 2025, the federal brackets are:
- 10% on income from $0 to $11,925
- 12% on income from $11,926 to $48,475
- 22% on income from $48,476 to $103,350
- 24% on income from $103,351 to $197,300
- 32% on income from $197,301 to $250,525
- 35% on income from $250,526 to $626,350
- 37% on income above $626,350
These amounts represent taxable income, which is gross income minus deductions. Someone earning $70,000 gross who takes the $15,750 standard deduction has taxable income of $54,250.
Let’s calculate the tax on $54,250 of taxable income:
- First $11,925 × 10% = $1,192.50
- Next $36,550 ($48,475 - $11,925) × 12% = $4,386.00
- Next $5,775 ($54,250 - $48,475) × 22% = $1,270.50
Total federal tax: $6,849
Notice that only $5,775 gets taxed at 22%, not the entire $54,250. The majority of income is taxed at 10% and 12%.
Marginal rate vs. effective rate
Marginal tax rate is the rate on the next dollar earned. For someone with $54,250 in taxable income, the marginal rate is 22%. Any additional income gets taxed at 22% until reaching the next bracket at $103,350.
Effective tax rate is total tax divided by total taxable income. Using the example above: $6,849 ÷ $54,250 = 12.6%. This represents the blended rate across all brackets.
The effective rate is always lower than the marginal rate (except for those entirely in the 10% bracket). Someone in the “22% bracket” might have an effective rate of 12-15%. Someone in the “32% bracket” might have an effective rate of 18-22%.
Understanding both rates helps with planning. The marginal rate indicates the tax impact of additional income or the tax savings from deductions. The effective rate represents the overall tax burden as a percentage of income.
Why raises never hurt
The fear of “earning less after a raise” persists despite being mathematically impossible under the marginal system.
Suppose someone earning $48,000 in taxable income (top of the 12% bracket) receives a $5,000 raise, bringing taxable income to $53,000. The new income crosses into the 22% bracket.
Before raise: Tax on $48,000 = $1,192.50 (10% bracket) + $4,329 (12% bracket) = $5,521.50
After raise: Tax on $53,000 = $1,192.50 (10% bracket) + $4,386 (12% bracket) + $990 (22% bracket on $4,500) = $6,568.50
Tax increase: $6,568.50 - $5,521.50 = $1,047
Take-home increase: $5,000 raise - $1,047 additional tax = $3,953
The raise results in $3,953 more take-home pay. The 22% rate applies only to the $4,500 of income in that bracket, not to the entire $53,000.
No raise of any size at any income level reduces take-home pay. Each additional dollar is taxed at the marginal rate, always leaving some portion to the earner.
Where the confusion comes from
Several factors create the persistent misconception:
Language ambiguity: Saying someone is “in the 22% bracket” implies all income is taxed at 22%. More accurate would be “in the 22% marginal bracket.”
Cliff effects in benefits: Some tax credits and benefits do phase out sharply or entirely at income thresholds. Someone might lose a $2,000 credit upon crossing an income threshold, creating a situation where more gross income results in less after-tax-and-credits income. This is real but distinct from the bracket system itself.
State taxes with different structures: Some state and local taxes have flat rates or different bracket structures that can create unusual interactions with federal taxes.
Social Security taxation thresholds: The percentage of Social Security benefits subject to federal tax changes at specific income levels, creating effective marginal rates higher than the bracket rate alone.
Medicare premium surcharges: IRMAA (Income-Related Monthly Adjustment Amount) adds surcharges to Medicare premiums above certain income levels, creating cliff effects.
These complications affect specific situations but don’t change the fundamental truth: the federal income tax bracket system never taxes additional earnings at a rate that exceeds 100%.
How deductions interact with brackets
Deductions reduce taxable income, with the benefit determined by marginal rate. A $1,000 deduction for someone in the 22% bracket saves $220 in federal taxes. The same deduction for someone in the 12% bracket saves $120. For a deeper comparison, see tax deductions vs. tax credits.
This makes deductions more valuable at higher income levels. The mortgage interest deduction, for example, provides larger tax savings to higher-income homeowners who both have larger mortgages and face higher marginal rates.
The standard deduction provides the same taxable income reduction regardless of income, but the dollar benefit varies. The $15,750 standard deduction saves $1,575 for someone entirely in the 10% bracket versus $5,040 for someone entirely in the 32% bracket.
How tax credits interact with brackets
Tax credits reduce tax liability directly, dollar for dollar, regardless of bracket. A $1,000 tax credit saves $1,000 for someone in the 22% bracket and $1,000 for someone in the 12% bracket.
This makes credits more egalitarian than deductions. A $2,000 credit provides the same benefit to all eligible taxpayers. A $2,000 deduction provides different benefits depending on marginal rate.
Refundable credits can reduce tax liability below zero, resulting in refunds even with no tax owed. Nonrefundable credits can reduce liability to zero but not below.
Strategies using bracket knowledge
Understanding brackets informs several financial decisions:
Retirement contribution timing: Contributing to a Traditional 401(k) or IRA provides a deduction at today’s marginal rate. If today’s marginal rate exceeds expected retirement marginal rate, Traditional contributions provide value. If retirement rate is expected to be higher, Roth contributions (no current deduction, no future taxes) may be preferable.
Income timing: Self-employed individuals with control over billing and receipt timing might shift income between years to avoid jumping brackets or to take advantage of lower-bracket space.
Roth conversion planning: Converting Traditional retirement accounts to Roth triggers taxes. Converting in years with lower income (job transitions, early retirement, market downturns) allows conversion at lower bracket rates.
Capital gains planning: Long-term capital gains have their own bracket structure with 0%, 15%, and 20% rates at different income levels. Realizing gains in years when income is lower can reduce the rate on those gains.
Bunching deductions: In years where itemized deductions would exceed the standard deduction, bunching additional deductible expenses (charitable contributions, prepaying property taxes if beneficial) maximizes value. In other years, taking the standard deduction simplifies filing.
Different brackets for different income types
Not all income is taxed at ordinary income rates:
Long-term capital gains and qualified dividends are taxed at preferential rates: 0% for lower incomes, 15% for most taxpayers, and 20% for highest earners. These rates apply regardless of the ordinary income bracket.
Short-term capital gains (assets held one year or less) are taxed as ordinary income, using the bracket rates.
Self-employment income is subject to self-employment tax (15.3% for Social Security and Medicare) in addition to ordinary income tax. This makes the effective marginal rate on self-employment income higher than the bracket rate alone.
Qualified business income from pass-through entities may qualify for a 20% deduction, effectively reducing the rate on that income.
State and local taxes add layers
Federal brackets are only part of the picture. Most states impose income taxes with their own bracket structures, ranging from flat rates (several states use a single rate) to graduated brackets (California’s top rate exceeds 13%).
Some localities add income taxes on top of state and federal. New York City residents face federal, state, and city income taxes simultaneously.
The combined marginal rate, federal plus state plus local, determines the actual tax on additional income. Someone in the 32% federal bracket living in California at the 9.3% state bracket faces a combined marginal rate above 41% before considering other taxes.
Common bracket misconceptions
“I should earn less to stay in a lower bracket.” Never beneficial. Higher brackets tax only the income within them, always leaving more take-home pay from more gross income.
“My entire income is taxed at my bracket rate.” No. Income is taxed progressively through all brackets up to your top bracket.
“Rich people pay lower rates than middle class.” Complex. Capital gains are taxed at lower rates than ordinary income, so income derived primarily from investments can face lower effective rates than salary income. But comparing bracket rates alone, higher incomes face higher marginal rates.
“I’ll owe more in taxes than I earned.” Impossible under marginal rates. The highest marginal rate is 37%, meaning even the last dollar earned keeps 63 cents after federal income tax (before state and other taxes).
Understanding how brackets actually work replaces fear and confusion with clarity. The system is designed to tax higher incomes at progressively higher rates while ensuring every additional dollar earned increases take-home pay.