Can a pay raise result in less pay??? (taxes)

behaviorkeltonAugust 19, 2007

I'm considering working a little on the side. It is possible that this will put me in the next higher tax bracket.

I'm not sure, but I think I have overheard conversations that suggest that it is possible to make less if your *just* edges over the next higher tax bracket.

So is there any advantage to keeping one's pay just a touch under the next bracket?

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devorah

no, no ,no. That is such an old myth. If your extra income pushes you into a new bracket, you will only be taxed at that rate on the money that goes over. There is no advantage to keeping your pay under the next bracket.

I don't know where the idea comes from that you can lose money by making more. It must be from the same source that gave us "working 9 - 5" Don't most of us work 8 -5?

    Bookmark   August 19, 2007 at 3:14PM
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behaviorkelton

Yes, I thought so... but I've never had to be concerned about that next bracket up!

It sounds sort of like:
"I don't want my mortgage to be too low or I lose the interest tax deduction"
That never made sense to me either.

However, given the complexity of the IRS and the goofiness of gov't regulations... I figured it might be possible for someone to actually make less because they make more!

Thanks

    Bookmark   August 19, 2007 at 4:18PM
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kitchenshock

devorah, I think this myth is a hang-over from the pre-Reagan days when the top tax rates were 70%. Back in the 50's,60's and 70's many people took the view that once you cross the 50% bracket you are working more for the benefit of the government then yourself, so why bother. In the 50's and early 60's the top rate was 91% so I could imagine at some point around 70%, one has to say, no thanks to making more money since the reward was not worth the effort. Remember these taxes were charged on earned income and not investment income.

    Bookmark   August 19, 2007 at 5:40PM
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steve_o

Keep in mind that your side business will have its own accounting and taxation rules. My ex sold "party goods" for several years. While we did earn some income from that, it was offset by business expenses (inventory, writeoffs, mileage, etc.) for several years.

    Bookmark   August 19, 2007 at 9:11PM
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richard_f

If the side income is from an independent business or work as an independent contractor, you'll also have to pay self employment taxes (both the employer and employee portions of social security and Medicare) of about 15% of income in addition to state and federal income taxes on the money you make after expenses.

Plan on filling out a schedule C with your 1040 as well.

    Bookmark   August 20, 2007 at 11:10AM
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behaviorkelton

Richard,
Thanks... darn.. I didn't consider that. I'll have to calculate that additional 15% and see if I still feel like giving up my free time!

    Bookmark   August 20, 2007 at 5:56PM
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celticmoon

Do watch out for the Alternative Minimum Tax. Tweaking your income can hurt if you are close to that kicking in.

And if you do start a side business, you will have to decide at the get go whether to set up your accounting to be "cash based" vs. based on product/inventory. (Cash based is simpler in that all that matters is what you collect - not what you bill, not what you are owed, just the cash you get. You deduct your expenses and pay tax on the net. No writing off losses.)

    Bookmark   August 20, 2007 at 11:13PM
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sparksals

For us, the additional income of me working a temp assignment put us into a higher tax bracket. I made a whopping $8K last year, married filing jointly. When I input dh's tax info into TurboTax, we were getting a $2K refund. Entered mine and it came out that we owed a small amount.

Now, I did make $8K last year and we lost a $2K refund, so we were $6K ahead, but there's something about owing money to Uncle Sam that really bites.

Can someone please explain the AMT in layman's terms? I hear that people get *stuck* with it. The title makes it sound like it's somewhat of a benefit. What conditions does one have to meet in order to be tacked the AMT?

    Bookmark   August 22, 2007 at 2:26PM
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richard_f

The AMT is a completely different income tax calculation that excludes most deductions and exemptions and uses different tax rates. You're supposed to calculate your tax both ways and pay which ever is higher, and all of the tax software packages will do this automatically.

The people who pay it most often are those with a lot of deductions for things like state income taxes, property taxes, etc. Since those deductions are disallowed under the AMT, their AMT tax amount is usually higher than their regular tax amount. It rarely effects people making less than $75,000 or so.

Here is a link that might be useful: http://en.wikipedia.org/wiki/Alternative_Minimum_Tax

    Bookmark   August 22, 2007 at 2:55PM
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celticmoon

Sparksals, had the right amount of tax been withheld from your 8k earnings? If they taxed you as though that was all your earnings, almost nothing would be withheld. (federal tax bite up to 15,650 is 0). But since you file jointly, all your dollars came on top of DH's, and therefore all are subject to the tax rate HIS income topped out at. (within the couple, he already benefited from lower rates on his initial dollars earned) That then is 15% of every dollar over 15,000 or 25% of every dollar over 64,000. So if little or nothing was withheld, that 2000 sounds like a 25% hit on your 8k. Think that is maybe what happened?

The Alternative Minimum tax was implemented in 1969 to keep high income people from avoiding taxes by claiming huge deductions. Deduct too much relative to your earnings and the IRS says "Nope" and hits you with the AMT. Problem is, this was all laid out with income and deduction numbers that have not adjusted for inflation. Salaries have risen, as have deductions (higher mortgages, home equity loans, etc), and a threshold of 40,000 is not the upper income threshold it was in 1969. ATM used to kick in for less than 1% of filers. Current estimates are it will affect 20% of filers by 2010.

Here is a link that might be useful: IRS ATM info

    Bookmark   August 22, 2007 at 3:29PM
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richard_f

While I have myself paid the ATM several times, I don't think it's a bad thing. Without it, people from states with low or no state income tax would share a disproportionately high proportion of the Federal tax burden. People shouldn't be able to completely deduct their way out of paying income taxes.

    Bookmark   August 22, 2007 at 9:05PM
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chiefneil

One other thing to note is that once you get to a certain income level you can no longer contribute to a Roth IRA.

    Bookmark   August 24, 2007 at 12:43AM
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