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bagelhead
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Post by bagelhead »

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Last edited by bagelhead on Wed Jan 01, 2020 6:20 pm, edited 1 time in total.
SteveKL
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Re: Marginal Tax Rate on Dual Income Couple

Post by SteveKL »

bagelhead wrote:ISeems like a bad deal to work when one's entire income is taxed at around 50%...
The top marginal tax bracket for a couple is 39.6% and applies only to MAGI above $457,600. State tax (if applicable) could nudge the top marginal rate close to 50%. The effective rate (total tax due divided by total income, after deductions) is nowhere close to 50%. Just saying.
bluejello
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Re: Marginal Tax Rate on Dual Income Couple

Post by bluejello »

Do not think about it in terms of marginal tax rate for the other person. If you are married filing jointly there is only one marginal and one effective tax rate, and it applies to both of you. Otherwise, you are engaging in the same erroneous thinking that causes people to say things like "well, there's no point in her working when all of her income just goes to pay for childcare".

This is erroneous because it's not just one person's income that is being taxed, nor one person's income that pays for childcare. The self-employed spouse does not start at a 39.6% effective tax rate any more than the W2 spouse starts at a 28% tax rate (since the self-employed spouse earns $150k).

Here's a chart for 2013:

Image

In your example where the couple's total income is $750k — not taking into account any deductions or fica, their total federal income tax bill would be $244,646. Making for an effective tax rate of 33%. Still ouch, but definitely not 50%.
Topic Author
bagelhead
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Post by bagelhead »

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kaneohe
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Re: Marginal Tax Rate on Dual Income Couple

Post by kaneohe »

bluejello wrote:....................................... Otherwise, you are engaging in the same erroneous thinking that causes people to say things like "well, there's no point in her working when all of her income just goes to pay for childcare". .............................................
If a couple is deciding if the non-working spouse should take a $60K job with taxes at 24K and a nanny at 36K for a net pay of $0K, isn't it valid to think she
is working for nothing even if the other spouse is paying ? That is to say there is no economic benefit to the couple if she works? (agree w/ bogelhead who is faster!)
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dodecahedron
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Re: Marginal Tax Rate on Dual Income Couple

Post by dodecahedron »

bagelhead wrote:
bluejello wrote:Otherwise, you are engaging in the same erroneous thinking that causes people to say things like "well, there's no point in her working when all of her income just goes to pay for childcare".
When I said "Seems like a bad deal when one's entire income is taxed at 50%", I was referring to the self employed spouse's income. Every dollar of that person's income, starting with dollar #1, is taxed at the couple's marginal rate.

If the analysis above is intended to help guide how much the lower income spouse should work (while the higher income spouse is fixed at full time work), why is it erroneous to think "well, there's no point in her working when all of her income just goes to pay for childcare"? Isn't the correct way to analyze this: Spouse makes $75/hr pre-tax, $38 after-tax. Is it worth it for her to work at this rate?
Yes, this is the correct way to think about the *marginal decision* of how much (if at all) the second spouse should work, if we take as *given* that the first spouse is going to earn $600K no matter what.

However, as you pointed out above, there are some potential mitigations to that 50% hit. Spouse may be able to set up a self-employed retirement plan to reduce the tax hit, and there may be some AGI deductions (e.g., for half of the self-employment tax, for self-employed health insurance and self-employed long-term care insurance). Also, to the extent that the self-employed spouse is building up a business that is increasing in value, there may be some unrealized capital appreciation in the business s/he is creating, which would not be subject to current taxation (and possibly the realization of that appreciation could be deferred until some point later in life when the couple's tax rates are lower, e.g., the business is sold after they retire.)
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JDCarpenter
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Re: Marginal Tax Rate on Dual Income Couple

Post by JDCarpenter »

Many years ago, we looked at it as: DW's last dollar has highest marginal rate, which is unlikely to change. Therefore, DH's first dollar (and all dollars) are taxed at that rate (technically, when FICA limits achieved, DH income is taxed less for remainder of year, but ....). Given need for childcare, home "work," and hours of both professions, DH is best employed as SAHD with just enough side job in profession to keep the powder dry for whenever situation might change.
Our personal blog (no ads) of why we saved/invested: https://www.lisajtravels.com/
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vectorizer
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Re: Marginal Tax Rate on Dual Income Couple

Post by vectorizer »

It gets even more complicated considering the roll-off and elimination of various credits and deductions. The tax table is just a rough estimate. For "middle" incomes (any income not very low or very high), marginal tax rates are practically impossible to calculate by pencil. Only a complicated spreadsheet with expert formula inputs, or more practically something like TurboTax, can really tell you your marginal rate given all the many income situations for a real-world couple.

For example, a few years ago, by me varying my income +/- $100, TurboTax was able to tell me that my (joint) marginal fed income tax was 44% mostly because of the roll-off of education credits -- even though we were in the 28% bracket in the tax rate table. (This does not include 4% additional state & local inc tax.)

IMHO, the only accurate way to get a good estimate of the tax implications of life decisions like spouse getting a job, is to use a TurboTax-like super spreadsheet that can take into account all of the factors, favorable and unfavorable.
bhsince87
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Re: Marginal Tax Rate on Dual Income Couple

Post by bhsince87 »

It is very complicated. We're in a similar situation. My wife has a business, and our combined incomes put us in the 33% marginal bracket, usually. She pays the 15.3% self employment tax on top of that. Or it could be 16.2% this year, if our AGI goes over 250k (another complication!)

With the deduction I usually ball park that tax as 12%. We have state and local on top of that of about 5%. So her marginal rate is 50%, in theory. And as others have mentioned, some deductions can be phased out at higher income levels.

Another kicker is if her income puts us over $250k AGI, we'll now have an additional 3.8% tax on investment income.

However, owning the business opens up the possibility of many new deductions. The home office deduction is good for us, since we use about 20% of the house to store inventory. We can also open a 401k for her under the business. And we can sometimes choose which year to take some income, so we can play games with that.

I've had an accountant recommend that we simply transfer "her" business to "me", and in effect, save the 12% or so self employment tax on the business income. We haven't done that. One reason is that while that self employment tax seems harsh, part of it is actually going to build extra Social Security credits for her, while I' maxed out for the year irregardless. That should have some pay off down the road.

Bottom line, there is no simple answer....
Time is what we want most, but what we use worst. William Penn
bluejello
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Re: Marginal Tax Rate on Dual Income Couple

Post by bluejello »

bagelhead wrote: When I said "Seems like a bad deal when one's entire income is taxed at 50%", I was referring to the self employed spouse's income. Every dollar of that person's income, starting with dollar #1, is taxed at the couple's marginal rate.

If the analysis above is intended to help guide how much the lower income spouse should work (while the higher income spouse is fixed at full time work), why is it erroneous to think "well, there's no point in her working when all of her income just goes to pay for childcare"? Isn't the correct way to analyze this: Spouse makes $75/hr pre-tax, $38 after-tax. Is it worth it for her to work at this rate?
Yes, I understood what you meant, and I politely disagree. The IRS does not tax the W2 income first and then the self-employed income (or vice versa). Both incomes are taxed simultaneously. There are 3 ways to look at the scenario you proposed (W2 spouse earning $600k, self-employed spouse earning $150k):
  1. W2 spouse fills up tax brackets 10% through 39.6%, first dollar of self-employed spouse's income starts at 39.6% tax rate
  2. Self-employed spouse fills up tax brackets 10% through 28%, first dollar of W2 spouse's income starts at 28% tax rate
  3. The first dollar of each spouse's income is taxed at 10%, up until they have earned $17,850 in total. Then the next dollar of each of their incomes after that is taxed at 15%, and so on and so forth.
You are choosing to look at this scenario as #1. I am saying that I think both #1 and #2 are the wrong way to look at the scenario, and that we should think about it as #3.

When you consider the scenario using #1 or #2, you are taking one of the spouse's income as "given", and thinking of the other spouse's earnings as additional to that first income. Why would you think about it that way? The IRS certainly doesn't think about it that way. Whose income should be taken as given — the higher earning spouse? The spouse with the more stable job (and how do you measure stable)? The spouse who enjoys their work more? The spouse who's been in their job longer?

If two people are both relatively high income earners (as is the case here), then when they get married they will end up paying more in taxes together than they would have separately. This "marriage penalty" for dual-income couples is a fact of the tax code, and in my opinion a travesty, but let's not get into politics here. However, this does not mean that one person's income somehow fills up the lower tax brackets and the second person starts at a higher tax bracket, therefore making it less worthwhile for them to work.

Similarly for childcare, the way I look at it is this:

- If only Person A works, our household take-home income will be $A
- If only Person B works, our household take-home income will be $B
- If we both work, our household take-home will be $C (where $C < $A + $B due to taxes)

Quite simply: which scenario would make us the happiest, as people and spouses and parents? Can we afford our lifestyle if only one of us works? Can we afford the additional cost of childcare if both of us work? I do not look at either person's income as "additional" to the other.
MindBogler
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Re: Marginal Tax Rate on Dual Income Couple

Post by MindBogler »

I think the distinction between these two lines of thought falls under the "agree to disagree" column. They're both valid ways of observing the same painting. The glass is half full and empty at the same time.
MN Finance
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Re: Marginal Tax Rate on Dual Income Couple

Post by MN Finance »

If the first spouse makes 600, then marginally speaking, adding income for the second spouse will obviously be taxed at 50% (top bracket, state, fica.) If you think that's a bad idea, then so be it. Doing it in theory is unnecessary, however, because just take your current return and add the income in (your software or the cpa's.) You'll know just about to the penny the true marginal rate.
bluejello
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Re: Marginal Tax Rate on Dual Income Couple

Post by bluejello »

kaneohe wrote: If a couple is deciding if the non-working spouse should take a $60K job with taxes at 24K and a nanny at 36K for a net pay of $0K, isn't it valid to think she is working for nothing even if the other spouse is paying ? That is to say there is no economic benefit to the couple if she works? (agree w/ bogelhead who is faster!)
First of all I disagree with your mental model — the childcare is not coming out of the $60k alone, it is coming out of both spouse's income. If the first spouse wasn't working, then they wouldn't need to pay for childcare either. You are erroneously thinking of one spouse's income as being taken for granted, and the second spouse's income as additional.

Second of all, even if we go with the way that you are thinking about things, there are short-term and long-term calculations. Even if the economic benefit is $0 in the short term, it is definitely positive in the long term. Children do not need to be looked after forever. Eventually they go to school and hopefully, one day they grow up. And people are not paid at the same rate forever either; they get raises and promotions.

So let's say the currently non-working spouse takes the $60k job and you pay $36k to a nanny for 6 years until the kid goes to school. Even if you consider the entire cost of the nanny to be deducted from this income (which again I disagree with, it should be deducted from both incomes), that is only 6 years. After that you don't have to pay a nanny anymore and thanks to raises and promotions, the spouse is now earning more than $60k and will do so until she decides to retire.

On the other hand, if the non-working spouse stays at home, it is going to be very difficult for them to rejoin the workforce 6 years later. The salary that they can command on the job market will almost certainly have fallen drastically. When you look at the net lifetime earnings, it is hugely financially positive for both spouses to work, even if the net economic benefit to the couple during the early childhood years is $0.
Topic Author
bagelhead
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Post by bagelhead »

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