How Tax Brackets and Payroll Deductions Work

“I don't want a raise — it'll push me into a higher tax bracket and I'll take home less.” This is the most common tax misconception, and it's completely wrong. Understanding how marginal tax brackets actually work can save you from leaving money on the table.

Marginal vs effective tax rate

The US uses a progressive tax system. Your income isn't taxed at a single flat rate — it's sliced into brackets, and each slice is taxed at its own rate. Only the income within each bracket is taxed at that bracket's rate.

2024 federal brackets (single filer)

Example: $85,000 salary

If you earn $85,000, here's how your federal income tax is actually calculated:

First $11,600  × 10% =  $1,160.00
Next  $35,550  × 12% =  $4,266.00
Next  $37,850  × 22% =  $8,327.00
                       ──────────
Total federal tax:     $13,753.00
Effective rate:         16.2%

Your marginal rate is 22% (the bracket your last dollar falls in), but your effective rate is only 16.2% ($13,753 / $85,000). That's the percentage you actually pay.

Payroll taxes: the other deductions

Federal income tax isn't the only deduction from your paycheck. FICA taxes fund Social Security and Medicare:

• Social Security — 6.2% on income up to $168,600 (2024 cap). Your employer pays another 6.2%.
• Medicare — 1.45% on all income, no cap. An additional 0.9% applies to income above $200,000.

Combined, FICA takes 7.65% of most paychecks. Unlike income tax, FICA is a flat rate on every dollar (up to the Social Security cap) — there are no brackets.

Pre-tax deductions that shrink your taxable income

Several common paycheck deductions reduce your taxable income before brackets are applied:

1. 401(k) / 403(b) contributions — Up to $23,000 in 2024. If you contribute $10,000, your taxable income drops by $10,000 before brackets are calculated.
2. Health insurance premiums — Employer-sponsored premiums are typically pre-tax, reducing both income tax and FICA.
3. HSA contributions — Up to $4,150 (individual) in 2024. Triple tax advantage: tax-free going in, growing, and coming out for medical expenses.

Sales tax: a different model entirely

Sales tax is a consumption tax, not an income tax. Two approaches exist worldwide:

• Exclusive (US model) — Tax is added at the register. A $100 item in a state with 8% sales tax costs $108.
• Inclusive (VAT model) — Tax is baked into the sticker price. A £100 item in the UK already includes 20% VAT — the pre-tax price is £83.33.

Five US states have no sales tax at all: Alaska, Delaware, Montana, New Hampshire, and Oregon. Most states exempt groceries and prescription drugs.

Taxes feel complicated because they are — intentionally so. But the core mechanics are simple: progressive brackets tax each slice of income at its own rate, and pre-tax deductions let you shrink the pie before the slicing begins.