Tax Help - What Do You do When Your Salary Increases

Increase in Salary

A significant change in your salary could have tax implications. Knowing what to look for and what to do in these situations can help you make the most of this change. Keep an eye on your adjusted gross income (AGI) to see if you're eligible for certain tax credits. Consider these examples:

You file as Single. You earn $50,000 per year and you're repaying a student loan. If you get a $2,000 year-end bonus, you lose part of your deduction for student loan interest.

You're filing Married Filing Jointly. You and your spouse earn $98,000 per year. Your combined raises are $3,000. Because your income now exceeds $100,000, you can't convert a traditional IRA to a Roth IRA.

Decrease in Salary

Similarly, a decrease in salary could put you in a position to take advantage of tax breaks for which you were previously not eligible. For example, you file as Single, normally make $55,000 per year, and you were covered by your employer's retirement plan. Because of a layoff, you are unemployed for three months and your income for the year is now $46,000. You can now deduct some of your traditional IRA contributions that would not have been deductible had you been employed all year.

Timing is everything

When you receive a sizable increase or decrease in salary is important. A year-end bonus could raise your AGI to the point where you become ineligible for a deduction, as in the first example above. If so, you might consider asking your boss to defer your bonus until the next calendar year.

Withholding

The withholding amount on your W-4 assumes you'll be working at the same salary all year. If your salary goes up or down dramatically, be sure to adjust your withholding so you don't have an unexpected balance due come tax time.