Tax Talk with Dr. Mary Marshall - Tax Tips for Students: How Tax Rates Work for U.S. Income Taxes

Another common tax question from students is about whether they should be considered a dependent on their parents' tax return. Although it is often discussed as a decision, a dependency determination requires a specific test with very clear guidelines.

One of the most common misunderstandings around taxes, especially for newer filers, is how tax rates work. In fact, there are many common myths about tax rates. You may have heard people mention that they don't want to accept a raise because it will cause them to move into a higher tax bracket or that they don't want a bonus because it will be taxed more than other income. These ideas have also become pervasive in popular television. For example, in the sitcom The Office (Season 6, Episode 23), Michael Scott suggests that it is sometimes beneficial to make less money because of tax effects. This installment will review common misconceptions about income tax rates.

Will a raise move me to a higher tax bracket?

The U.S. income tax system uses a progressive, marginal rate structure. This does mean that the marginal tax rate increases as someone earns more money; however, the higher rate only applies to income that falls within the range of the new tax bracket. The 2024 tax brackets for single filers are shown in the table below. Taxpayers who make $20,000 pay 10% on the first 11,600 and 12% on the income above $11,600. The higher rate is only used to calculate taxes on the income that falls in the second bracket. Even taxpayers in the highest brackets will only pay 10% on the first $11,600 in income.

So when someone gets a raise, they might move to a higher tax bracket. However, only the portion of their taxable income that falls in the new bracket will have the higher tax rate.

Are bonuses really taxed at a higher rate than other income?

Despite common belief, the answer to this question is no. It often seems like they have had a higher tax rate because of the withholding requirements, but the actual tax rate for any taxpayer is not determined until the end of the year.

Taxes are withheld from employees' paychecks using a set of tables that predict how much total income that employees will receive over the course of the year. When an employee receives a higher than usual amount, the withholding tables overestimate how much that single pay period's higher wages will influence annual income and, consequently, increases withholdings. But withholdings are only estimates of what a taxpayer will eventually owe. Once the tax return is filed and total taxable income is calculated, the normal marginal rate schedule (shown above) applies equally to "normal" wages and to bonuses. If withholdings were too high when the bonus was paid, the taxpayer is more likely to receive a refund when the tax return is filed.