FINANCIAL FRESHMAN #074

TL;DR → Earning more income will never “hurt” you. The U.S. uses a progressive tax system, so only the top portion of your income is taxed at higher rates. Understanding marginal and effective tax rates will help you see exactly how much you’ll owe and gives you a clearer picture of your take-home pay.

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Take a Deep Breath

When it comes to personal finance, income taxes are certainly one of the most misunderstood topics out there. And on this blog, I feel an urge to talk about any topic that’s at the intersection of “misunderstood” and “incredibly important.”

In our history, we’ve written about calculating take-home pay and published a five-part series on taxes in general. What we haven’t discussed in detail, however, is the mechanics of how the progressive tax system works in the United States. These mechanics are as simple as they are misunderstood.

In this post, my goal is to cover a little bit of tax history, teach you the tax vocabulary you’ll need to successfully navigate your pay stub, and talk through the mechanics of how your income taxes actually function.

A Bit of History

In this context, when we use the word progressive, we’re simply referring to any taxation that increases relative to your income. And in the United States, federal income taxes haven’t always been structured this way.

In 1861, Abraham Lincoln signed the Revenue Act of 1861 into law, which introduced the first federal income tax as a means to fund Civil War efforts. This act imposed a 3% flat tax on every American citizen, on every dollar earned in excess of $800. If you’re curious, in 2025 dollars, that equates to the first ~$28,000 being tax-free.

This act was quickly followed by the Revenue Act of 1862, which formally created the Bureau of Internal Revenue (later named the IRS). It also transitioned 1861’s flat tax into the country’s first progressive tax—specifically, one that looked like this:

• No tax collected on the first $600 of income
• A 3% tax collected on income between $600 and $10,000
• A 5% tax collected on income above $10,000

While this explains the structure of a progressive tax system, today’s set up unfortunately isn’t quite so simple. Let’s talk about some vocabulary first.

Tax Vocabulary

Before we get into the numbers, it helps to revisit a few terms you’ve already seen on this blog. These ideas shape how different tax systems are structured and give context for why the United States uses the approach it does.

• Flat Tax System: A structure where everyone pays the same tax rate, no matter their income
• Progressive Tax System: A structure where tax rates increase as income increases, which is how federal income taxes work today

Now that the foundation is in place, there are a few new terms that will make the rest of this post easier to follow. These focus on how the tax system actually functions on your paycheck.

• Tax Brackets: The ranges that determine which tax rate applies to each portion of your income
• Marginal Tax Rate: The rate applied to the last dollar you earned as your income moves through the brackets
• Effective Tax Rate: The average rate you pay across all of your income, calculated by dividing total taxes owed by total income

Immediately, this marginal tax rate definition dispels a myth that is all too common in the world of personal finance. If you learn anything from this post, know that it’s not possible to get a raise and earn less money due to reaching a higher tax bracket. Only the income that reaches that threshold is subject to the higher rate—not every dollar.

With the foundational knowledge in place, let’s take a look at what these numbers look like today!

Taxes in 2025

If you’re interested in some light reading, the IRS maintains an up-to-date table of federal income tax rates on their website. Here’s a snapshot of what those rates look like today for a single filer:

If the numbers outlined in a table ever get confusing, think of them presented as buckets positioned one right after another. Your income follows the green arrows, and only flows into the next bucket once the preceding bucket has been filled.

Would you rather learn by example? Let’s call back to Alex, the graphic designer earning $60,000 that we introduced in our post last week.

As a single filer subject to the above tax rates, Alex can expect his annual federal tax burden to be $5,216. Let’s walk through how we got there.

• His income subject to taxes will be $45,400. This is his salary of $60,000 minus the standard deduction of $14,600 for a single filer.
  • Need a refresher on the standard deduction? Check out this post.
• Of this $45,400, the first $11,600 will be subject to a 10% tax. This means Alex will owe $1,160.
• The next $33,800 of his income ($45,400 – $11,600) will be subject to a 12% tax. This adds another $4,056 to his total tax bill.
• $1,160 + $4,056 = $5,216

This means that Alex’s marginal tax rate is 12%, and that none of his income will be taxed at any rate higher than that. We could calculate his effective tax rate by dividing his tax bill of $5,216 by his salary of $60,000. Hint, it would be 8.7%.

Final Thoughts

By understanding how tax brackets work, you’ll have a clearer picture of what to expect come tax time—whether you’re filing as a single individual today or planning for joint filing in the future. You can even take your projected salary after graduation and estimate your effective tax rate right now.

Most of your peers don’t know how this stuff works, which gives you a big advantage when managing your money. Remember, tax brackets do change over time, so staying informed will help you make smarter financial decisions as your income grows.