Use Your Tax Info for Election Analysis

I saw a headline this morning saying that (fill in your candidate of choice) was planning on raising the marginal tax rates.  It’s the crazy election season. When everyone seems to play loose with the truth and headlines don’t have any relationship to the story that follows.

Let’s talk tax rates for a minute. I am asked by clients a lot; “What is my tax rate?” Well, it depends-which rate? First is the marginal rate. This is the top rate you are paying tax on and the one most people think about when talking taxes. A single taxpayer with $60,000 in W-2 income and no adjustments will pay tax on $50,650 after her single deduction and exemption are subtracted (taxable income). Of that $50,650, $8,375 will be taxed at 10%, the next $25,625 will be taxed at 15%, and the remaining$16,650 will be taxed at 25%. Her highest tax rate equals her marginal rate so her marginal rate is 25%. The effective tax rate is the actual percentage of tax. In our example, the taxpayer is paying $8845 in tax. Divide the tax by the taxable income ($50,650) and you get an effective tax rate of 17.46%. The effective tax rate is always lower than the marginal rates.

Right now we technically have 6 marginal tax rates. They are 10%, 15%, 25%, 28%, 33% and 35%. These are part of the so called Bush tax cuts. When they went into effect in 2001 and were not permanent changes. They were only short term changes and Congress has had to “extend” them on a regular basis. If When Congress gets back to work, one of the more urgent issues they will have to do is decide if these tax cuts will be extended again. They are set to expire at the end of the year. If nothing is done, we will revert to 15%, 28%, 31%, 36%, and 39.6% marginal tax rates.

Neither party has to “raise” the tax rates; it’s automatic if there is no tax cut extension. And both parties have said they are for continuing the current lower rates for most taxpayers. There is a difference of opinion over increasing the higher rates. But for most taxpayers, there should be no change in their taxes if Congress extends most of the Bush tax rate cuts. No promises in the future if Congress tackles real tax reform.

With the influence of the Tea Party and the fate of the Bush tax cuts to be decided, taxes will be a major issue of this election. So take a moment to figure your marginal and effective tax rates. Start with your taxable income (1040 Line 43, 1040A Line 27 or 1040EZ line 6). Next look at the tax rate table ( Download 2011 Tax Rate Table)  for your filing status (single, married filing joint…). Which bracket does your taxable income fit into? That is your marginal rate. (A little confused? Use the example above for a guide.) To get your effective tax rate, divide your tax (1040 line 44, 1040A line 28 and 1040EZ line 10) by your taxable income.

As you read and hear about the different tax proposals during the election season, keep your taxable income, marginal tax rate and effective tax rate handy to compare what the proposals will really mean to your taxes.

And please read the comments because Paul makes a good point.

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Comments

[Paul C]

I think the "effective tax rate" as you describe in your post is different from what most people would actually think of as their actual overall tax rate. If that person was to say what their income is they would say $60,000, not the $50,650 that is their taxable income. That would give an overall rate of 14.74%. I'm not saying that the given 17.46% effective rate or that the definition is incorrect, just that people don't usually think of taxable income as the amount of their income. I think that is understandable since taxable income is just a construct of the tax return used in the return to determine tax. It really has nothing to do with what people actually receive as income. For example, there could be two people, each with that $60k annual income and one of them has substantially more deductions which reduce their taxable income to less that the other who takes the standard deduction. Both of them would say they make $60k, which would be their total income on the return, barring other items. For purposes of understanding what actual overall rate they pay, I think people should focus on the rate of total tax/total income to have the better understanding of what they are paying.

[Trish]

Paul
You make a good point. In a post a couple of years ago, I called it the "real world tax rate." And I agree that taxpayers need to know it too. But with the media and politicians tossing out "marginal" and "effective" I wanted to give readers an understanding of those terms.

[Paul C]

Absolutely, I agree, people should be knowledgeable of what those terms mean so they can better understand the discussion of the issues, as well as understand the limitations of what the terms mean.

[shane Knight]

I completely agreed on this with you everyone has to maintain the details at there end at the time of declaration there will be no hassle it can be produce to media an politicians