Marginal tax rate: statutory 15%, effective 30%

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kaneohe
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by kaneohe »

Kevin M wrote:
kaneohe wrote: Perhaps the wiki needs to have some numerical examples to really drive the concepts home.
So join the party and be one of the people who is cracking you up. :wink:

Kevin
I bit..............

How about a sequence of questions or ilustrations such as:
The tax table lists the 2014 boundary/border/barrier between 15% and 25% taxable income as 73800:
1a) Taxable income is all ordinary income 10K < that dividing line. Ordinary income increases by 10K. What happens to tax?
1b) Replace ordinary income w/ LTCG/QDIV in 1a)
2a) Taxable income is all ordinary income at that dividing line. Ordinary income increases by 10K. What happens to tax?
2b) Replace ordinary in w/ LTCG/QDIV in 2a)
Questions 1 & 2 illustrate the ordinary income and LTCG/QDIV rates in various areas.

3)Taxable income which includes 20K of LTCG/QDIV is 10K less than the boundary
3a) Ordinary income increases by 10K. What happens to the tax?
3b) Ordinary income increases by 20K. What happens to the tax?
3c) Ordinary income increases by 30K. What happens to the tax?
3d,e,f) Replace ordinary income w/ LTCG/QDIV in 3a,b,c
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by tfb »

Kevin M wrote:Of course for completeness, more sections would have to be added, since there's now range of LTCG&QD income that is taxed at 20%
I have a chart for that too. I agree it's too complicated but it's not my fault!

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Re: Marginal tax rate: statutory 15%, effective 30%

Post by adrift »

Kevin M wrote:Of course for completeness, more sections would have to be added ...
tfb wrote:I agree it's too complicated ...
It is complicated. But, it is not complete.

I've been aware of the 30% rate for several years. I attempt to do ROTH conversions as close as possible to the top of the 15% bracket as I can.

Using Turbo Tax, I just simulated adding an extra $5,000 beyond the top of the 15% bracket to my Roth conversion. What I see is that indeed my Tax on this extra $5,000 is 30%. But, that my total tax on this extra $5,000 is 24.54%.

Do you know what the additional complication is?
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by Kevin M »

^adrift, can you be more specific. What do you mean by "total tax"?

Your hypothetical tax increased by a certain amount. You can then divide the additional tax amount by different amounts of taxable income to get different ratios. If you divide the additional tax by the additional income, you get 30%. If you divide the additional tax by some other income value, like your total income, the denominator will be larger and the ratio (%) will be smaller.

So what are the numerator and denominator you use to get 24.54%?

Kevin
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by sscritic »

My total tax includes my state and IRMAA (if you consider that a tax, but you won't see it for two years).
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by Kevin M »

adrift wrote: It is complicated. But, it is not complete.
To be complete I think it would have to be ridiculously complicated. The latest chart addresses the three statutory rates applied to LTCG&QDI, 0%, 15%, 20%, and the net investment income tax of 3.8%. There are other phase-outs and phase-ins that also affect marginal tax rate, such as the amount of social security that gets taxed, phase-out or limitation of various credits, etc., and then there's AMT to boot. And as sscritic mentions above, this only applies to Federal income tax.

One thing that would make it more clear to me would be to somehow explicitly reference the statutory LTCG&QDI and net investment income tax rates. This is because these rates are specifically referenced on the tax worksheets; the 0%/15%/20% rates are applied on one worksheet, and the 3.8% rate on another.

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Re: Marginal tax rate: statutory 15%, effective 30%

Post by sls239 »

I'm holding off because I'm confused on the wording (what should be changed?)
How about setting it up so that the "tax brackets" have "nominal marginal rates of ..." but your "personal marginal rate for a given type of income" might be quite different.

You can determine your personal marginal rate for a given type of income by...

Some common causes of a high personal marginal rate are...


I know the terms aren't technical, but I think they are pretty clear. I don't know what the style guidelines are for the Wiki.
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by adrift »

Kevin M wrote:^adrift, can you be more specific. What do you mean by "total tax"?

Your hypothetical tax increased by a certain amount. You can then divide the additional tax amount by different amounts of taxable income to get different ratios. If you divide the additional tax by the additional income, you get 30%. If you divide the additional tax by some other income value, like your total income, the denominator will be larger and the ratio (%) will be smaller.

So what are the numerator and denominator you use to get 24.54%?

Kevin
I'm using "Tax" (line 44) and "total tax" (line 61) as they appear on Form 1040.

I have to file Form 1116 to compute my Foreign Tax Credit (line 47). I can only take credit for part of the Foreign Taxes I pay. But, adding the extra hypothetical $5000 in income, increases the amount of credit I can take.

So, for line 44 I have 1500/5000 (30%) and for line 47 I have 1227/5000 (24.54%).

Our tax code is more complicated than can be summarized in any of the pictures or explanatory paragraphs posted in this thread. I posed my post as a question to see if anyone would guess what the additional complication was. There may be other complications that I am unaware of. But, this is the one that applies to me.
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by Kevin M »

Since I think the Wiki should cite reputable sources as much as possible, I would start any discussion of "tax brackets" with what the IRS actually says about the tax rate schedules:
1040 Instructions, 2013 wrote:The Tax Rate Schedules are shown so you can see the tax rate that applies to all levels of taxable income. Do not use them to figure your tax. Instead, see the instructions for line 44.
IRS Publication 17 wrote:The Tax Rate Schedules are shown so you can see the tax rate that applies to all levels of taxable income. Do not use them to figure your tax. Instead, see chapter 30.
At some point it has to be pointed out that what the IRS says regarding the Tax Rate Schedules is misleading, since as we've seen here, you cannot necessarily "see the tax rate that applies to all levels of taxable income" in these schedules. If I interpret "taxable income" to be the number on 1040 line 43 labeled "Taxable income", what I see in the Tax Rate Schedules is that a 25% rate applies to the top level of my taxable income. However, the actual tax rate that applies to the top level of my taxable income (for Federal tax purposes) is either 15% or 30%, depending on how much of my Roth conversion I recharacterize.

I think I first saw the use of the term "statutory" used by forum member Doc in reference to tax rates. I have been using the term "statutory marginal tax rate" to refer to what I see in the Tax Rate Schedules, and "effective marginal tax rate" to refer to the marginal tax rate that actually applies to me. The way the Wiki is using the term "marginal tax rate", I guess "effective" is redundant, and also can be confused with "effective tax rate", which generally is considered the overall rate of tax paid on either taxable income (1040 line 43), adjusted gross income (1040 line 37), or total income (1040 line 22).

The IRS bulletin I've referenced several times above uses the term "statutory rate", as in:
For this article, the marginal tax rate is the statutory rate at which the last dollar of taxable income is taxed.
and
A return’s marginal tax rate is the highest statutory tax rate bracket applicable to that tax return.
and
Tax Years 1993 through 1996 had a five-rate tax bracket structure (with a maximum statutory tax rate of 39.6 percent), a limitation on some itemized deductions, and a phase-out of personal exemptions for some upper-income taxpayers.
The last quote implies that the use of "statutory tax rate" applies to the rates shown in the Tax Rate Schedules (and uses the term "tax bracket" to describe the ranges of income to which different statutory tax rates apply). But in a footnote:
Marginal tax rate as cited in this article is the highest statutory rate on taxable income. It includes ordinary tax rates and capital gains tax rates. This concept does not include the effects of AMT or tax credits
So here they use "statutory rate" to apply to cap gains tax rates as well as tax rates shown in the Tax Rate Schedules (which apply to ordinary income). A statutory tax rate is a tax rate that is specified by statute. This means that statutory tax rates include rates in the Tax Rate Schedules, as well as any other tax rates that are specified by statute, such as tax rates on long-term capital gains and qualified dividends, and the tax rates used to determine Alternative Minimum Tax.

I don't think the 30% marginal tax rate that might apply to some of us would be referred to as a statutory rate, although it results from the combination of statutory rates.

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Re: Marginal tax rate: statutory 15%, effective 30%

Post by Kevin M »

adrift wrote: So, for line 44 I have 1500/5000 (30%) and for line 47 I have 1227/5000 (24.54%).
Ah, so you used a different numerator, not a different denominator.
adrift wrote:Our tax code is more complicated than can be summarized in any of the pictures or explanatory paragraphs posted in this thread. I posed my post as a question to see if anyone would guess what the additional complication was.
Oh, I didn't know you wanted us to guess--I thought you were asking why. I didn't try to guess your specific situation, but I did mention phase in and out of tax credits as an additional complication that the chart doesn't address, and probably can't address.

I think the chart does a good job of helping to visualize the calculation of tax on line 44 with respect to how LTCG&QDI are treated.

EDIT: But I think your example does demonstrate that one really needs to use tax software (or do the calcs manually) to see the overall impact of any changes. As noted in my OP, I thought my higher marginal rate might have been due to the phase-out of the AOTC, but it wasn't. I can see directly from the tax worksheet how much I think I have to recharacterize to reduce my marginal rate from 30% to 15%, but before making the decision I'll see if there are any other effects below line 44.

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Re: Marginal tax rate: statutory 15%, effective 30%

Post by adrift »

Kevin M wrote: I think the chart does a good job of helping to visualize the calculation of tax on line 44 with respect to how LTCG&QDI are treated.
I don't disagree with that. It took me a while to figure out when I first encountered the situation.

I want to thank you for something you posted in an earlier thread. I've been using the online version of TurboTax for years. Mostly, based on your comments about "Forms" in an earlier thread, I've converted to the desktop version. I wish I'd done so years ago.
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by Kevin M »

^Yes, forms mode makes it much quicker to figure out what's going on; glad to have helped you discover it.

I just made some more progress in figuring out how much of my Roth conversion to recharacterize (using forms mode). I just change the converted amount on the 1099-R, then in addition to looking at how the tax owed or refund amount changes, I print form 1044 and the QD&CG tax worksheet to a PDF file. I can then bring up the two versions and compare side by side to see exactly which numbers changed and by how much (and pop numbers into a spreadsheet if things aren't immediately apparent).

My situation is similar to yours. (Edited). There is a range of taxable income from about $3,000 above the top of the 15% bracket to about $300 below it for which my marginal rate is 25% due to changes in the foreign tax credit.

I still need to look at state taxes :(

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Re: Marginal tax rate: statutory 15%, effective 30%

Post by grabiner »

grabiner wrote:There is an income level X which is normally considered the top of the 15% tax bracket. Ordinary income less than X is taxed at 15%; ordinary income above X is taxed at 25%. Qualified dividends and capital gains in an income range below X, counting your ordinary income first, are taxed at 0%; qualified dividends and capital gains above X are taxed at 15%. Thus, if your ordinary taxable income is less than X, but your qualified dividends and capital gains bring the total taxable income above X, your marginal tax rate is 30%. An extra $1 of ordinary income is below X and is taxed at 15%, but it also pushes $1 of qualified dividends from the range below X to the range above X, so that $1 is taxed at 15% as well.
I updated the wiki article with wording similar to this
Wiki David Grabiner
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by Kevin M »

grabiner wrote:
grabiner wrote:There is an income level X which is normally considered the top of the 15% tax bracket. Ordinary income less than X is taxed at 15%; ordinary income above X is taxed at 25%. Qualified dividends and capital gains in an income range below X, counting your ordinary income first, are taxed at 0%; qualified dividends and capital gains above X are taxed at 15%. Thus, if your ordinary taxable income is less than X, but your qualified dividends and capital gains bring the total taxable income above X, your marginal tax rate is 30%. An extra $1 of ordinary income is below X and is taxed at 15%, but it also pushes $1 of qualified dividends from the range below X to the range above X, so that $1 is taxed at 15% as well.
I updated the wiki article with wording similar to this
Looks fine to me. For comparison, here is the wording I suggested earlier:
Another unusually high Federal marginal tax rate of 30% can result from adding a dollar of ordinary income that is taxed at 15%, but that also causes a dollar of long term capital gain and qualified dividend income to be taxed at 15% instead of 0%. This can occur if the value of one's total taxable income is in the 25% bracket of the tax rate schedule applicable to the taxpayer. This can best be understood by working through an example using the Qualified Dividend and Capital Gain Tax Worksheet, which is one of the methods used to calculate the tax reported on Form 1040 (line 44 for 2013).
Everyone's brain works differently, so a different wording will make more sense to some than others.

If using David's wording, it would be more complete to say "There is an income level X which is normally considered the top of the 15% tax bracket for a given filing status."

Also, it might be worth noting that this marginal rate reflects only "Tax" (2013 Form 1040 line 44), and does not factor in alternative minimum tax, credits, and other taxes (2013 Form 1040 lines 45-60), which can affect the true marginal rate as reflected in "total tax" (2013 Form 1040 line 61). Note my case posted above where there is a range of "taxable income" from about $3,000 above the top of the 15% bracket to about $300 below it for which my marginal tax rate is 25% due to the impact of total income on the foreign tax credit.

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Re: Marginal tax rate: statutory 15%, effective 30%

Post by gerntz »

Anyone think the difficulty in figuring out where the income breaks & types are to minimize taxes isn't deliberate?
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by Kevin M »

gerntz wrote:Anyone think the difficulty in figuring out where the income breaks & types are to minimize taxes isn't deliberate?
^This is off topic, and discussing it is likely to get the thread locked. Please, let's not go there.

Thanks,

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Re: Marginal tax rate: statutory 15%, effective 30%

Post by LadyGeek »

I agree.
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by Electron »

Along similar lines, the 10% bracket sees a marginal tax rate of 25% for additional ordinary income when the 0% bracket is in play. In these cases extra ordinary income is not always welcome.

There are actually many cases where the marginal tax bracket is higher than many expect and it can be a little hard to understand at times. In the days when itemized deductions and personal exemptions were subject to phaseout, the marginal bracket increased. Both factors could be in play at the same time. As I recall the itemized deduction phaseout was smooth but the personal exemption phaseout had a stair step effect because of the calculation and thresholds involved. I think these two phaseouts may be back for those with very high income.

Another example is itemized medical deductions that must exceed some percentage of AGI. Additional income reduces the deduction and affects the marginal bracket.

The Alternative Minimum tax adds yet more examples and especially for the case where the AMT deduction is being phased out but still in play. People find that extra capital gains see an effective tax rate of 21.5% in one case. That comes from 15% + the AMT 26% rate divided by 4. The AMT deduction is phased out with a 25% factor involved. I have my taxes in a spreadsheet where I can easily test all these cases and it is sometimes quite a challenge to explain what is going on.
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by Electron »

kaneohe wrote:I've found the picture to be much more intuitive than words.
One interesting thing about the 0% bracket for Capital Gains and Qualified Dividends is that someone could have an extremely high income and yet still be in the 0%, 10% or 15% bracket for Ordinary Income. They can also qualify for the 0% bracket for Capital Gains and Qualified Dividends for a portion of that income.

Consider an individual with $1M in Capital Gains and Qualified Dividends and a small amount of Ordinary Income. The Ordinary Income is first offset with the Standard or Itemized Deduction and the Personal Exemption. The result could be that Ordinary Income is in the 0%, 10%, or 15% bracket. Any remaining space in the 15% bracket becomes the 0% bracket for a portion of the Capital Gains and Qualified Dividends. The remaining Capital Gains and Qualified Dividends are then taxed at 15% or possibly higher with the latest tax laws.
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by MnD »

I like the 28% bracket.

When I added $100 in W-2 income, my taxes went up by $28
When I added $100 in QD income my taxes went up by $15.
Above all the phase-outs of the middle-class "breaks" and below the richy-rich penalties.

We also opened up a little room between where we are at and the AMT due to lower deductions.
It's still close but it's looking like we probably won't hit AMT in any year before retirement.
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by Kevin M »

Electron wrote: One interesting thing about the 0% bracket for Capital Gains and Qualified Dividends is that someone could have an extremely high income and yet still be in the 0%, 10% or 15% bracket for Ordinary Income. They can also qualify for the 0% bracket for Capital Gains and Qualified Dividends for a portion of that income.
Yes. Another example: A couple, MFJ, could have enough ordinary income to just offset their deductions and exemptions, and have up to $72,500 of qualified dividends and LTCG and pay no federal income tax (assuming no AMT or other additional taxes).

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Re: Marginal tax rate: statutory 15%, effective 30%

Post by LadyGeek »

Found in this thread: Oblivious Investor interview at Vanguard Mike Piper has an example of marginal tax rate (Why "oblivious" investors may know more than they think):
Once you start taking Social Security, your marginal tax rate—the tax you pay on each additional dollar earned—can be higher than your tax bracket. For instance, if you're in the 15% tax bracket, your marginal rate could be higher than 15% because each dollar you take from a traditional IRA doesn't just cause 15 cents of income tax; it also causes up to 85 cents of your Social Security income to be taxable. In this scenario, it actually increases your marginal tax rate to 27%.
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by Kevin M »

^Yep, this is another one that's already in the Wiki article. EDIT: and another reason this sentence from the Wiki article is misleading:
An individual's tax bracket is the range of income for which a given marginal tax rate applies.
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by tfb »

Mike Piper wrote:For instance, if you're in the 15% tax bracket, your marginal rate could be higher than 15% because each dollar you take from a traditional IRA doesn't just cause 15 cents of income tax; it also causes up to 85 cents of your Social Security income to be taxable. In this scenario, it actually increases your marginal tax rate to 27%.
Some people think our seniors are getting hosed due to this fact, but ... (FICA taxes from employer and employee are not included in the working side).

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Re: Marginal tax rate: statutory 15%, effective 30%

Post by sscritic »

Kevin M wrote:^Yep, this is another one that's already in the Wiki article. EDIT: and another reason this sentence from the Wiki article is misleading:
An individual's tax bracket is the range of income for which a given marginal tax rate applies.
Kevin
How about this:
A tax rate bracket is a range of income with a given name specified as a rate, e.g., the 15-percent tax rate bracket. An individual's tax rate bracket is the tax rate bracket whose name includes the highest rate reached by the individual's taxable income.
reference:
the maximum taxable income in the 15-percent rate bracket in the table contained in subsection (a) (and the minimum taxable income in the next higher taxable income bracket in such table) shall be 200 percent of the maximum taxable income in the 15-percent rate bracket in the table contained in subsection (c) (after any other adjustment under this subsection)
26 USC 1

I agree that the marginal rates you pay may have nothing to do with tax rate bracket percentages, but tax rate brackets exist, they have names, and the names include a percent, that percent matching the marginal rate given in the tables of sections (a), (b), (c), and (d) of 26 USC 1 as modified by other sections of 26 USC 1, e.g., the "Bush tax cuts."
In the case of taxable years beginning after December 31, 2000—
(i) the rate of tax under subsections (a), (b), (c), and (d) on taxable income not over the initial bracket amount shall be 10 percent, and
(ii) the 15 percent rate of tax shall apply only to taxable income over the initial bracket amount but not over the maximum dollar amount for the 15-percent rate bracket.
And thus the 10% bracket was birthed. 26 USC 1 (i)(1)(A) [Wow, I feel like I am giving a bible reference. Is that allowed?]
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by dbr »

A tax bracket is just a pair of numbers in a table that is used as part of the computation of income tax due with the input to that look-up table being some number that is derived by a complex process from all the raw inputs to the tax return. Alternatively a bracket is defined by a pair of cut-points in a tax rate schedule that is used in the same way. Trying to use the concept off-hand for some corner cutting analysis of what one might pay in taxes doesn't really work. The percent "tax rate" that nominally labels the region between that pair of numbers is certainly neither the effective tax rate nor one of the marginal tax rates for a tax payer.
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by manwithnoname »

LadyGeek wrote:Found in this thread: Oblivious Investor interview at Vanguard Mike Piper has an example of marginal tax rate (Why "oblivious" investors may know more than they think):
Once you start taking Social Security, your marginal tax rate—the tax you pay on each additional dollar earned—can be higher than your tax bracket. For instance, if you're in the 15% tax bracket, your marginal rate could be higher than 15% because each dollar you take from a traditional IRA doesn't just cause 15 cents of income tax; it also causes up to 85 cents of your Social Security income to be taxable. In this scenario, it actually increases your marginal tax rate to 27%.
This post in an excellent example of why microanalysis of marginal tax rates to a particular stream of income overstates the actual amount of taxes attributable to that income. 85% of my SS is included as income. However if 27% of my SS taxable benefits were taxed, the amount of tax would be 150% of the total income tax on all of my income. The reason marginal rates on a particular income stream have little or no significance in determining overall tax paid is because there are so many exemptions, deductions, exclusions, 0 tax rates, etc in the tax law which reduce the amount of income actually taxed on line 44 of the 1040.
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by The Wizard »

Marginal Tax Rate or Effective Marginal Tax Rate should be the name of what we're discussing here.
And for each specific instance, the particular REASON for the discrepancy should be noted.
The Wiki can't identify the particular reasons, since they vary from instance to instance, but it could give a few examples...
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by Kevin M »

sscritic wrote: How about this:
A tax rate bracket is a range of income with a given name specified as a rate, e.g., the 15-percent tax rate bracket. An individual's tax rate bracket is the tax rate bracket whose name includes the highest rate reached by the individual's taxable income.
reference: <snip>
I like it! I've spent some time mentally rewriting it, but I like your wording better than anything I came up with.

Since the article is on marginal tax rates, it seems there should be a tie in with the topic. How about adding a sentence like, "This tax rate bracket may or may not represent the individual's marginal tax rate, depending on the types of income included in taxable income."?

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Re: Marginal tax rate: statutory 15%, effective 30%

Post by Kevin M »

dbr wrote:The percent "tax rate" that nominally labels the region between that pair of numbers is certainly neither the effective tax rate nor one of the marginal tax rates for a tax payer.
But it could be the marginal tax rate on one's taxable income if taxable income consists only of "ordinary income", and one has no credits or other taxes (below 2013 Form 1040 line 44). Correct?

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Re: Marginal tax rate: statutory 15%, effective 30%

Post by Electron »

Kevin M wrote:But it could be the marginal tax rate on one's taxable income if taxable income consists only of "ordinary income", and one has no credits or other taxes (below 2013 Form 1040 line 44). Correct?
I think the marginal tax rate would be higher than the tax bracket rate if any income based limitations or phaseouts are in play. One example would be itemized medical expenses that must exceed some percentage of AGI. Any phaseout of itemized deductions or personal exemption based on income would be another example. There are probably other cases such as additional Social Security income being taxed.
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by Kevin M »

^Yes, my list of exceptions wasn't comprehensive, but the point remains that the "tax rate bracket" marginal rate could actually be one's marginal rate. My guess is that this is the case for a large percentage of taxpayers--those whose only income is earned income, and maybe with a little interest. I do taxes or help do taxes for people for whom this is the case.

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dbr
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by dbr »

Kevin M wrote:
dbr wrote:The percent "tax rate" that nominally labels the region between that pair of numbers is certainly neither the effective tax rate nor one of the marginal tax rates for a tax payer.
But it could be the marginal tax rate on one's taxable income if taxable income consists only of "ordinary income", and one has no credits or other taxes (below 2013 Form 1040 line 44). Correct?

Kevin
Of course. If it is, then it is. But you are knowledgeable about taxes and have a mental picture how one thing can in fact be a legitimate value for something that is quite a different thing and also when it won't be a legitimate value for that other thing. It would be like a guy that always leaves a dollar tip for coffee and a donut at diners and one day the check is $5 and somebody says that guy leaves 20% tips. He doesn't leave 20% tips; he leaves $1 tips and this time that amounted to 20%.
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by Electron »

Kevin M wrote:My guess is that this is the case for a large percentage of taxpayers--those whose only income is earned income, and maybe with a little interest. I do taxes or help do taxes for people for whom this is the case.
I think you are correct. A typical working individual has earned income, some interest income, and perhaps an IRA or 401K. Much less common are stocks or mutual funds in a taxable account. As a result, they don't take advantage of the 0% rate on Capital Gains or Qualified Dividends, and they don't get involved with phaseouts or itemized deduction limitations. Their marginal tax rate is often the same as their stated tax bracket. However, there will be cases where additional income puts them into the next higher tax bracket. I envy these taxpayers in terms of the simplicity of their taxes and being able to quickly estimate the impact of extra income.

Your earlier post on a couple filling the 15%/0% bracket with Qualified Dividends illustrates possibly the most generous part of our tax code. That is really a gift and is the total opposite of what we see in other parts of the tax code including such things as the AMT.
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by dbr »

Electron wrote:
Kevin M wrote:My guess is that this is the case for a large percentage of taxpayers--those whose only income is earned income, and maybe with a little interest. I do taxes or help do taxes for people for whom this is the case.
I think you are correct. A typical working individual has earned income, some interest income, and perhaps an IRA or 401K. Much less common are stocks or mutual funds in a taxable account. As a result, they don't take advantage of the 0% rate on Capital Gains or Qualified Dividends, and they don't get involved with phaseouts or itemized deduction limitations. Their marginal tax rate is often the same as their stated tax bracket. However, there will be cases where additional income puts them into the next higher tax bracket. I envy these taxpayers in terms of the simplicity of their taxes and being able to quickly estimate the impact of extra income.

Your earlier post on a couple filling the 15%/0% bracket with Qualified Dividends illustrates possibly the most generous part of our tax code. That is really a gift and is the total opposite of what we see in other parts of the tax code including such things as the AMT.
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by grabiner »

Electron wrote:
Kevin M wrote:My guess is that this is the case for a large percentage of taxpayers--those whose only income is earned income, and maybe with a little interest. I do taxes or help do taxes for people for whom this is the case.
I think you are correct. A typical working individual has earned income, some interest income, and perhaps an IRA or 401K. Much less common are stocks or mutual funds in a taxable account. As a result, they don't take advantage of the 0% rate on Capital Gains or Qualified Dividends, and they don't get involved with phaseouts or itemized deduction limitations. Their marginal tax rate is often the same as their stated tax bracket.
There are two common exceptions for taxpayers with children: the phase-out of the earned income credit at low incomes (which adds 15.98% to the marginal rate with one qualifying child, and 21.06% with two), and the phase-out of the child tax credit at higher incomes (which adds 5% to the marginal tax rate).
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by Electron »

Kevin's point that the marginal tax rate for many taxpayers is the same as their tax bracket rate is easily illustrated by examining the Tax Tables in the Form 1040 Tax Booklet. It is also an interesting exercise to examine those tables.

The Tax Table starts out in the 10% bracket and continues into the first part of the 28% bracket. At the start of the table you can increase the taxable income by $100 and see that the tax rises $10. As you turn the pages you will see the progression to the 15%, 25%, and 28% brackets. At the transition points between brackets you may see a dollar change between the two rates. For example, I noticed a $12 difference for a single taxpayer at a taxable income level of $8950 before the tax rate increased to 15%. I hadn't noticed this before but the tax rate for married filing jointly rises to 15% farther down the table as compared to the single taxpayer.
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by Kuyper »

Do any of these tax prep calculators offer a line graph of a tax payers marginal rate at each additional dollar that is added? I think this would be an educational visual of the idiosyncrasies of the tax code.
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by rkhusky »

Kuyper wrote:Do any of these tax prep calculators offer a line graph of a tax payers marginal rate at each additional dollar that is added? I think this would be an educational visual of the idiosyncrasies of the tax code.
I tried doing this with the child tax credit included, but the fact that one rounds up to the nearest $1000, causes large oscillations in the plot.
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by manwithnoname »

grabiner wrote:
Electron wrote:
Kevin M wrote:My guess is that this is the case for a large percentage of taxpayers--those whose only income is earned income, and maybe with a little interest. I do taxes or help do taxes for people for whom this is the case.
I think you are correct. A typical working individual has earned income, some interest income, and perhaps an IRA or 401K. Much less common are stocks or mutual funds in a taxable account. As a result, they don't take advantage of the 0% rate on Capital Gains or Qualified Dividends, and they don't get involved with phaseouts or itemized deduction limitations. Their marginal tax rate is often the same as their stated tax bracket.
There are two common exceptions for taxpayers with children: the phase-out of the earned income credit at low incomes (which adds 15.98% to the marginal rate with one qualifying child, and 21.06% with two), and the phase-out of the child tax credit at higher incomes (which adds 5% to the marginal tax rate).
Taxpayers do not care about phase outs of tax benefits. All they want to know is whether they will get a larger refund this year. A year ago I prepared a tax return for a single mom with 2 children who received a 6k raise after a promotion which reduced her EIC from 5k to 3k. She was annoyed that her refund was reduced by 2k and insisted that I must have made a mistake because her refund should have been larger than last year. She was clueless about phase out of the EIC and thought it was unfair to reduce her EIC because her income had increased by 6k.
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by Kevin M »

Electron wrote:It is also an interesting exercise to examine those tables.
You also have to be careful if using tax tables to evaluate your statutory marginal tax rate for small dollar changes or changes from a lower (upper) boundary of one range to an upper (lower) boundary of another range, because the same tax is paid on a specified range of income. Starting at $3,0000 fifty-dollar ranges (at least X but less than X+50) are used. The tax tables apply the rate from the tax rate schedules to the midpoint of each tax table range.

So if you increase income from $3,000 to $3,049, no additional tax is owed, but if you increase from $3,049 to $3,050 five dollars of additional tax is owed, as it will be if you increase taxable income from $3,000 (lower boundary of range) to $3,099 (upper boundary of next range). So even though you are "in the 10% bracket", your marginal rate could be significantly different than what is indicated in the applicable tax rate schedule.



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Re: Marginal tax rate: statutory 15%, effective 30%

Post by Kevin M »

manwithnoname wrote:[
Taxpayers do not care about phase outs of tax benefits. All they want to know is whether they will get a larger refund this year. A year ago I prepared a tax return for a single mom with 2 children who received a 6k raise after a promotion which reduced her EIC from 5k to 3k. She was annoyed that her refund was reduced by 2k and insisted that I must have made a mistake because her refund should have been larger than last year. She was clueless about phase out of the EIC and thought it was unfair to reduce her EIC because her income had increased by 6k.
Yes, the exact thing happened a couple of years ago when I prepared my niece's taxes. I've reorganized her finances and asset location (to ensure she doesn't exceed the investment income limit), and have had her make large 401k and traditional IRA contributions to increase her EIC. Her taxes are almost $5,000 less than they would have been without taking these steps, but she'll still probably only focus on the refund she'll be getting, which is much smaller since she had almost nothing withheld (and has other sources of income like RMD from inherited IRA).

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Re: Marginal tax rate: statutory 15%, effective 30%

Post by Electron »

The IRS tax tables can mask the marginal tax rate for the general case when small dollar changes are involved. I'd just look at the change in tax for a $100 increment in income.

Alternately, one can use the Tax Rate Schedules available in Publication 17 on page 263 or Form 1040-ES. Those schedules cover all tax brackets from 10% through 39.6%. The following text is provided in Publication 17.

"The Tax Rate Schedules are shown so you can see the tax rate that applies to all levels of taxable income. Do not use them to figure your tax. Instead, see chapter 30."
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by LadyGeek »

Kevin M wrote:Comments on terminology. I don't believe the IRS publications use the term "tax bracket"--at least a search of Pub 17 did not find it. The terms used are "tax rate" and "tax rate schedules". "CFR 601.602: Tax forms and instructions" uses the term "Tax Rate Tables". I also don't find the term "marginal tax rate" anywhere in Pub 17; I don't even find the word "marginal".

However, in searching irs.gov for "marginal", I found the terms "tax bracket" and "marginal tax rate" used extensively in The Individual Income Tax Rates and Tax Shares bulletin article and associated statistical tables. Here is the latest bulletin on that page: Individual Income Tax Rates and Shares, 2010. The "Income and Tax Concepts" section of the bulletin goes into great detail defining marginal tax rates, and uses the term "bracket" a couple of times.

Maybe the IRS is trying to shield the general public from additional confusing by not using these terms in its general publications.

taxes.about.com says "Each tax rate applies to a specific range of taxable income, which is called a tax bracket." So according to this definition, the term "15% tax bracket" means the range of income taxed at 15%. This usage seems consistent with the IRS usage in the documents cited above. This also is the definition used in the BH Wiki.
Wikipedia wrote:Tax brackets are the divisions at which tax rates change in a progressive tax system (or an explicitly regressive tax system, although this is much rarer). Essentially, they are the cutoff values for taxable income — income past a certain point will be taxed at a higher rate.
However, no reference for this definition is cited, so some person just made it up AFAIK. Anyway, this definition defines "brackets" as divisions or cutoff values, not ranges of income. This is not consistent with the way the IRS uses the term in the document cited above.

The BH Wiki also does not cite any IRS sources for definitions of "marginal tax rate" or "tax bracket. A YouTube video from the Tax Foundation is the cited reference.

I wonder if our Wiki should stick with the IRS terminology used in its publications intended for the general public when discussing taxes. Otherwise, how about citing some other IRS sources?

Kevin
A bit late, but I added an IRS definition for marginal tax rate. sscritic gave some behind-the-scenes help to define "tax-bracket." I added "rate-bracket" since that's also in 26 U.S. Code § 1 - Tax imposed.

See: Marginal tax rate

Also note that another editor added a FAQ section on Tax bracket.

Update: I used Kevin M's IRS tax bulletin reference to define marginal rate.
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by rkhusky »

Electron wrote:The IRS tax tables can mask the marginal tax rate for the general case when small dollar changes are involved. I'd just look at the change in tax for a $100 increment in income.

Alternately, one can use the Tax Rate Schedules available in Publication 17 on page 263 or Form 1040-ES. Those schedules cover all tax brackets from 10% through 39.6%. The following text is provided in Publication 17.

"The Tax Rate Schedules are shown so you can see the tax rate that applies to all levels of taxable income. Do not use them to figure your tax. Instead, see chapter 30."
The marginal rate fluctuates even more when the Child Tax Credit is involved. A $1 change in income can result in additional tax of $50 or a marginal rate of 5025%. Even using a $100 increment of income can look like a marginal rate of 75%. (Assuming income is taxed at 25%)
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by Kevin M »

There are several hard cutoffs that can cause a big jump in a tax credit or a complete loss of a tax credit. Earned Income Tax Credit (EIC) and Retrement Savings Credit are two that can be affected this way.

In working on my niece's tax return the last few days, I determined that by contributing $2,000 more to her 401k in 2013 she would have received an additional $943 in tax credits; an average marginal rate of 47.15%: 10% reduction in normal tax, 16% increase in EIC, and 21.15% increase in retirement savings credit. The 16% EIC is linear over the range I played with, but the maximum retirement savings credit jumps from $200 to $400 to $1,000 at specified boundaries. However, unlike the EIC the RS credit is not refundable, so in her case it would have been limited to her tax before credits of $823.

A couple of years ago I saw that her investment income was exceeding the EIC limit, as discussed in this thread: Bogleheads • View topic - Tax efficiency and Earned Income Credit. We "relocated" most of her stock funds to her inherited IRA in 2012 to reduce her investment income below the cutoff threshold, thus enabling her to qualify for the EIC starting in 2013. I also had her make significant 401k contributions and maximum traditional IRA contribution in 2013, all of which resulted in an additional $4,670 in tax savings and additional credits, or 24.25% of the total 401k and IRA contributions.

I didn't bother looking at the marginal rates as income just crossed the boundaries where big changes occur, but just looking at the above numbers as "average marginal rates", this is someone "in the 10% bracket" with an average marginal rate of 24.25% based on 401k/IRA contributions, and potentially 47% if 401k contributions had been $2K more.

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Re: Marginal tax rate: statutory 15%, effective 30%

Post by House Blend »

Here's an interesting little tax nightmare for you obsessive compulsive planners out there. As Kevin M reminded us at the top of this thread, you can pay tax at the marginal rate of 30% if you:
a) have taxable income that puts you in the 25% bracket, and
b) subtracting off your qualified dividends and LT cap gains puts you in the 15% bracket.

We can put this effect on steroids by combining it with the peculiar tax features of SS benefits. Let me work through an example:

You are single, retired, and taking SS benefits and RMDs.
Your income in 2013 consists of
$10,000 in qualified dividends,
$25,000 in SS benefits,
$25,000 in RMDs and other forms of ordinary income.
You take the standard deduction.

What is your marginal tax rate for ordinary income?

After filling out the SS Benefits Worksheet, you discover that $15,975 of your SS benefits are taxable. So the tax computation goes like this:

Code: Select all

$10,000  qualified dividends
$15,975  taxable SS benefits
$25,000  RMDs and other ordinary income
-------
$50,975  AGI
-$3,900  one exemption
-$7,600  standard deduction for seniors
-------
$39,475  taxable income
The top of the 15% bracket is $36,250, so only $3,225 = $39,475 - $36,250 of your qualified dividends are taxed. The rate is 15%.
Using the tax rate schedules, $3,975 is the tax on your $29,475 of non-dividend income, for a total tax bill of

$3,975 + 15% of $3,225 = $4,458.75.

What happens if we add $100 to the ordinary income?

This exposes another $85 of your SS income to tax, so your AGI increases by $185. In turn, this exposes another $185 of your qualified dividends to tax, so your tax goes up by

15% of $185 + 15% of $185 = $55.50.

Your marginal tax rate is 55.5%.

You can probably cook up a MFJ version of this nightmare, but you can't just double all of the income figures, because the base amounts for figuring taxation of SS income are not double the amounts for singles.
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by tfb »

House Blend wrote:Your marginal tax rate is 55.5%.
I would take a high marginal tax rate but low actual tax paid any day. Taxcaster shows 58% for your example, likely due to rounding. Single age 66, $10k QD + $25k SS + $25K RMD => $4,459 in federal income tax. Add $100 to RMD makes it $4,517, an increase of $58. Meanwhile, a person not on SS with $10k QD + $50k IRA withdrawal pays $7,060. Add $100 to the IRA withdrawal makes it $7,085, an increase of $25. I can well afford to pay $58 on the extra $100 when I'm paying only $4,459 versus $7,060.
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by House Blend »

^Yes, I think the discrepancy of a few dollars is caused by using tax tables rather than the tax rate schedules. The tax tables are in increments of $50, so when you add exactly $185 to taxable income, your tax doesn't increase by 15% of that.

So Taxcaster is giving the "true" tax, but the tax rate schedules give IMO a better measure of what is happening.
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Re: Marginal tax rate: statutory 15%, effective 30%

Post by grabiner »

tfb wrote:
House Blend wrote:Your marginal tax rate is 55.5%.
I would take a high marginal tax rate but low actual tax paid any day.
Agreed. Having a high marginal tax rate isn't bad; it's just something which affects a lot of your decisions, such as whether to use a traditional or Roth retirement account, whether to pay down your deductible mortgage or invest the money (note that itemized deductions are not considered in determining SS taxation), and whether to hold corporate or municipal bonds (note that municipal bond income is still counted for SS taxation).
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