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It is a common belief that moving into a higher tax bracket will cause you significant financial hardship. People have given away large sums for a tax deduction or even accepted lower pay believing they are actually saving money by maintaining a lower tax bracket. This post explains why this is incorrect and illustrates what a tax bracket transition really means for you.

The Myth
The basic belief is that tax brackets are retroactive and that all income is subject to your highest tax bracket’s percentage rate. The chart below illustrates the tax amounts a person would be subject to if this logic were applied.

(Click to enlarge)

The Reality
Only the income above the minimum amount for any given tax bracket is subject to that bracket’s rate.

For example:
If you are filing single and made $30,000 in 2008 you would be in the 15% tax bracket. Your first $8,025 would be subject to 10% in taxes. The remainder ($21,975) would be taxed at 15%.

This chart illustrates the actual tax breakdown for each taxable income group:

(Click to enlarge)

This detail view illustrates the different tax brackets as they apply to the income of a person filing single. The red line is a reference to help illustrate the slope of the tax amounts below.

(Click to enlarge)

This final chart illustrates the myth vs reality when one’s income moves from one tax bracket to another. The blue vertical bars indicate the tax brackets. The red zone illustrates the incorrect assumption that your tax rates apply retroactively. The green zone is your true net income.

(Click to enlarge)

Summary
This post should dispel the myth that your current tax bracket applies to 100% of your income. While taxes are complicated by many factors, this basic rule still applies. Don’t let yourself be fooled into believing that you are actually saving money by lowering your tax bracket. You should make tax-deductible donations as you see fit, but don’t think you’re saving any money by doing so.

More information
IRS 2008 tax tables
Chart source data (Google Docs spreadsheet)