Many people often misunderstand how their income is taxed. One common misconception is that more income always means paying a higher overall tax rate. While this is technically true, the way the tax system works can be confusing. Let’s break it down and clear up the confusion with a simple visual!

How Income is Taxed: The Progressive System

In the U.S., income is taxed using a progressive system. This means that as your income increases, it’s taxed at different rates, with higher levels of income being taxed at higher rates. But here’s where the misunderstanding typically happens: when new income enters a higher tax bracket, people often think all of their income is taxed at that new, higher rate. This is a common mistake!

In reality, each portion of your income is taxed at different rates, depending on the tax bracket it falls into. So, while your income may be taxed at a higher rate for a portion of it, the lower portion is still taxed at the lower rates.

Example: Breaking It Down

Remember that states have their income brackets alongside the federal level. For simplicity purposes, we're going to look at examples strictly on the federal side. Let’s look at a single filer in 2025 whose income is $200,000. There are the federal rates for a single filer in 2025:

Federal Tax Rates (Single Filer in 2025):

10%: $0 - $11,925

12%: $11,926 - $48,475

22%: $48,476 - $103,350

24%: $103,351 - $197,300

32%: $197,301 - $250,525

35%: $250,526 - $626,350

37%: $626,351 and up

Here’s how it looks at the federal level:

• The first portion of your income will be taxed at the lowest rate.
• As your income increases, the next portion will be taxed at a higher rate, and so on, until all of your income is accounted for.

These different levels (or tax brackets) are part of the progressive system. Each new level of income is taxed at a higher rate, but only that portion of the income, not the entire amount.

Marginal Tax Rate vs. Effective Tax Rate

When discussing taxes, two key terms often come up: marginal tax rate and effective tax rate:

• Marginal Tax Rate:
  • This is the tax rate applied to the last dollar of income you earn. It’s helpful when determining the tax impact of additional income or deductions. The marginal rate shows what tax bracket your new income will fall into, but it does not apply to all of your income. For example, if your income is $200,000, only the portion above $197,300 falls into the 32% tax bracket. The rest is taxed at progressively lower rates. In the example provided, the marginal tax rate would be 32%.
• Effective Tax Rate:
  • This is the overall tax rate that reflects how much of your total income is actually taxed. It’s calculated by dividing the total amount of taxes paid by your total taxable income. This is the number that truly represents how much of your income is taxed in practice. In the example, the effective tax rate would be 20.53%.

The marginal tax rate helps you understand how new income will be taxed and is useful when making decisions about earning more income or claiming deductions. However, the effective tax rate gives a clearer picture of how much you pay in taxes relative to your total income.

The Bottom Line

So yes, more income gets taxed higher. However, making more income is still a good problem, even if it means paying more taxes for it. You earned those dollars, after all!

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