Therehas been a lot of BUZZ lately about “effective tax rate” in light of the publicrelease of Mitt Romney’s tax returns.
Howshould a taxpayer evaluate a tax rate, especially his/her own?
Whenwe speak of “effective tax rate” we generally mean dividing the “total tax”(Line 61 for 2011) number from a Form 1040 by the Adjusted Gross Income (Line37 for 2011).
Butit that a true picture? Should the taxfigure in the calculation be Line 61 or Line 55? Line 55 is the federal income, or alternativeminimum, tax liability less allowable “non-refundable” tax credits. Line 61 includes other taxes such as “self-employmenttax”, unreported FICA taxes, and the penalty on premature withdrawals from apension account. In my opinion youshould use Line 55 to determine the true “effective income tax rate”.
Andwhat about refundable credits reported under the “Payments” section of thereturn, such as refundable portions of the Earned Income Credit, AmericanOpportunity Credit, Homebuyer’s Credit, and Child Tax Credit. These credits should be deducted from theamount on Line 55 in determining the federal income tax liability that is usedin determining “effective income tax rate”.
Aswe “speak” I am looking at a 2010 tax return from a married couple with onechild in high school. One spouse worksfull time and one works part time. TheAGI is $134,957, and Line 55 and Line 60 (the appropriate line for 2010) areboth $17,999.
Their“effective tax rate” under the normal calculation is 13 1/3%. But the AGI includes a deduction for aspousal IRA contribution. Their “TotalIncome” is $137,407, so should their effective tax rate be 13.1%?
Thefull-time spouse contributes to a 401(k), which reduces his gross taxableincome. Should the 401(k) contributionbe added back to Line 22, when calculating a true “effective tax rate”?
Andwhat about tax-exempt municipal bond interest reported on Line 8b? Should this amount be added to either TotalIncome or Adjusted Gross Income? With myexample the couple had $1,030 in municipal bond interest, so this wouldminutely effect their effective tax rate calculation.
Becausethey own a mortgaged home and live in NJ the couple has substantial itemizeddeductions. If we look at the tax rateas Line 55 divided by Line 41, AGI less itemized deductions, the rate is15.86%. And if we use “Taxable Income”after deducting personal exemptions the result is 17.56%.
Theyare in the 25% tax bracket (and they are not victims of the dreaded AlternativeMinimum Tax), so their “marginal tax rate” is 25%. If they had $5,000 more of additional income(taxed as ordinary income) they would pay $1,250 more in income. Every additional $1.00 of “ordinary” incomeis taxed at 25%, and conversely every additional $1.00 of deductions saves them25% ($100 more of charitable contributions reduces their liability by $25 –though they would actually be $75 “out of pocket”).
Ifthe couple took a premature withdrawal from a pension plan they would pay 25%in federal income tax on the income, and, unless they qualify for an exemption,an additional 10% in penalty tax. So theamount of the withdrawal would actually cost 35% in combined federal taxes. A $10,000 withdrawal would only put $6,500 “inpocket”.
Andwhen determining the actual cost of additional income one must add theappropriate state and local income taxes and, if the additional income is wageincome or net earnings from self-employment, applicable payroll taxes (FICA taxwithholding or “net” self-employment tax after factoring in the corresponding adjustmentto income).
Butevery additional $1.00 of qualified dividends or long-term capital gains istaxed at 15%. For lower income taxpayersevery additional $1.00 of qualified dividends or long-term capital gains couldbe taxed at 0%.
Sometimesadditional income is effectively taxed at a rate that is substantially morethan their “marginal tax rate”.
Becauseof the way Social Security and Railroad Retirement benefits are taxed, it ispossible that every additional $1.00 of income, regardless of the source, istaxed as $1.85. Such a person who is inthe 15% tax bracket will actually pay 27.75% in federal income tax onadditional ordinary income, and a person in the 25% bracket will pay 46.25%!
Whilequalified dividends and long-term capital gains for such a person in the 15%bracket are separately taxed at a rate of 0%, additional income of this naturefor a Social Security recipient could be taxed at 12.75%! And tax-exempt income reported on Line 8b areincluded in the calculation of taxable Social Security and Railroad Retirementbenefits, so additional income in this category may actually be taxed.
Soyou see, as with just about everything else when it comes to taxes, it ain’tsimple.
TTFN
Hiç yorum yok:
Yorum Gönder