Am I calculating the marginal tax rate correctly here?

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Brian2d
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Am I calculating the marginal tax rate correctly here?

Post by Brian2d » Wed Dec 05, 2018 9:13 pm

Just want to make sure I'm understanding calculating marginal tax rate correctly:

Assume the following:
AGI: $216,000
Taxable Income $204,000
Long Term Capital Gains + Qualified Dividends: $14,000
Taxable Income Less LTCG + Qual Divs: $190,000

Am I correct that the the correct marginal tax rate in this example would be: 32% + 3.8% Net Investment Income Tax = 35.8%.

Even though the person has a taxable income that would put them in the 35% tax bracket, because the LTCG and qualified dividends are only taxed at 15% their marginal tax rate should be based on the $190,000, which would imply 32%.

Thanks!

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grabiner
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Re: Am I calculating the marginal tax rate correctly here?

Post by grabiner » Wed Dec 05, 2018 10:42 pm

Does your marginal tax rate include the entire Net Investment Income Tax? This starts at $200K. If you have $202K of non-investment income, then your marginal tax rate for the ACA surtax is 3.8% only on additional investment income, and 0.9% on other income such as salary which is not subject to the full NIIT. If you have less than $200K of non-investment income, then your marginal tax rate for the ACA surtax is 3.8% on all income.

For the regular tax, 32% is the correct marginal rate unless you hit some other phase-out in the tax code. For example, if you have any dependents, an additional $1000 in income would cost you $50 of tax credit, making the marginal tax rate 37% before ACA surtax, and 37.9% or 40.8% including the NIIT.
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Brian2d
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Re: Am I calculating the marginal tax rate correctly here?

Post by Brian2d » Wed Dec 05, 2018 11:29 pm

Thanks Grabiner. For the additional point, that's a good clarification I hadn't thought about, that if non-investment income is under 200K, any additional dollar increases the amount subject to NIIT. My goal here is to figure out taxable vs tax-exempt bonds, so I think for that purpose either way the NIIT should be included in the marginal rate. However, the point you raise could be another argument in favor of Traditional vs Roth 401k contributions if non-investment income is below 200K.

sandramjet
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Re: Am I calculating the marginal tax rate correctly here?

Post by sandramjet » Thu Dec 06, 2018 6:07 pm

Sorry if this is a "detour" but I have a question about how to correctly calculate marginal rates as well. In particular, for the case where you will qualify for the American Opportunity Tax Credit (assume up to the full amount of credit ... 2500), it seems like having this is equivalent to lowering the marginal rates if you are below the AGI limit for the AOTC, otherwise they would be unchanged. Is this a reasonable way to look at this?

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grabiner
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Re: Am I calculating the marginal tax rate correctly here?

Post by grabiner » Thu Dec 06, 2018 11:17 pm

sandramjet wrote:
Thu Dec 06, 2018 6:07 pm
Sorry if this is a "detour" but I have a question about how to correctly calculate marginal rates as well. In particular, for the case where you will qualify for the American Opportunity Tax Credit (assume up to the full amount of credit ... 2500), it seems like having this is equivalent to lowering the marginal rates if you are below the AGI limit for the AOTC, otherwise they would be unchanged. Is this a reasonable way to look at this?
There are several effects.

60% of the AOTC is a non-refundable credit. If your tax is so low that the non-refundable portion of the AOTC, plus other non-refundable credits, reduces your tax to zero, then your marginal rate is zero.

If you are in the phase-out range, the AOTC phase-out adds 12.5% to your marginal tax rate if you are married filing jointly, 25% if you are single. A married couple in the phase-out range who earned an additional $1000 of income would pay $220 more in income tax (since the phase-out is in the 22% bracket), and lose $125 of AOTC, for a 34.5% marginal tax rate. A single would lose $250 of AOTC, for a 47% marginal tax rate. (Note that this credit is based on modified AGI, not taxable income, so a traditional IRA contribution or student loan interest will increase the amount of AOTC you get, but a deductible contribution to charity will not.)

If you are above or below the phase-out range, the AOTC does not change your marginal tax rate. If you are in the 22% tax bracket but below the phase-out range, you get $2500 of AOTC. Adding $1000 to your income results in an extra $220 of tax, and does not change your AOTC, so you still have a 22% marginal tax rate.
Wiki David Grabiner

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FiveK
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Re: Am I calculating the marginal tax rate correctly here?

Post by FiveK » Fri Dec 07, 2018 1:37 am

If it helps to see things in chart form, consider using the personal finance toolbox spreadsheet. E.g., for the OP's situation, given $14K LTCG, W-2 income only, and no pre-tax deductions, the marginal rate on the W-2 income is
Image

That shows the 32% + 3.8% = 35.8%, 32% + 0.9% = 32.9%, and 35% + 0.9% = 35.9% rates already discussed.

The AOTC situation is left as an exercise.... ;)

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