TIL: No more worrying about tax brackets

[dixonge]

So basically this is one of those things that I probably learned at one point, but evidently it didn't sink in. Most of the time I think of tax brackets as applying to my entire income. It seems I was misunderstanding the entire concept of marginal tax rates...

Why You Shouldn’t Worry About Entering A Higher Tax Bracket

 

[gauss]

+1 Yep - what matters is how far into it you are going.

 

[nun]

+1 Yep - what matters is how far into it you are going.

Well that's true for income, but to get all you dividends tax free you need to stay within the 15% bracket. Also what about ACA credits and other benefits.......

 

[pb4uski]

Yes, a common misconception that sometimes drives me nuts in that some people in the 25% tax bracket will complain so loudly about how taxes are so high and its not worth working because they earn $100k and pay $25k to the feds.

And when you point out to them that it just isn't true they can't understand and tell me how wrong I am, but if you take Taxcaster and model $100k of income for a MFJ couple with standard deductions the tax is $11,444 or 11% of income even though they are in the 25% bracket.

 

[Neill]

So basically this is one of those things that I probably learned at one point, but evidently it didn't sink in. Most of the time I think of tax brackets as applying to my entire income. It seems I was misunderstanding the entire concept of marginal tax rates...

Why You Shouldn’t Worry About Entering A Higher Tax Bracket

When you make decisions you would typically be driven by your marginal rate. How does a mortgage look after tax, should I convert my IRA to Roth IRA, should I sell that stock or invest in a municipal bond? You do these calculations using the marginal rate.
Your next realization will be that looking at Federal tax tables may not help you understand your marginal rate. The rules are so complex that you have to model what you want to do with tax s/w. It's just not as easy as saying stuff like 'my capital gains will be taxed at 15%'. Too many phaseouts and parallel systems. You can easily think your marginal tax rate is 28% when it's really 35% or 24% etc.

 

[RetireAge50]

Yes, a common misconception that sometimes drives me nuts in that some people in the 25% tax bracket will complain so loudly about how taxes are so high and its not worth working because they earn $100k and pay $25k to the feds.



And when you point out to them that it just isn't true they can't understand and tell me how wrong I am, but if you take Taxcaster and model $100k of income for a MFJ couple with standard deductions the tax is $11,444 or 11% of income even though they are in the 25% bracket.

I agree with you but they might be in the 25% bracket AND paying 25% to the Feds if each of them made $100,000 (if they also count social security taxes).

 

[Senator]

I agree with you but they might be in the 25% bracket AND paying 25% to the Feds if each of them made $100,000 (if they also count social security taxes).

If you count income taxes, employment taxes, state taxes, property taxes, sales taxes, etc. you likely pay well over 50%.

 

[razztazz]

The last 2 posts are good illustrations of why anybody who tries to sell a "single rate flat tax" is pushing that just ain't so. It's not that 4 or 5 tax brackets make the code unfair and complicated and having one rate would make taxes fair and uncomplicated. It's all that other mishigahss going on behind the green door that makes than tax code complicated leading to at least the perception of unfairness. You can have 25 tax brackets and a far simpler tax code

 

[dixonge]

Well that's true for income, but to get all you dividends tax free you need to stay within the 15% bracket. Also what about ACA credits and other benefits.......

When you make decisions you would typically be driven by your marginal rate. How does a mortgage look after tax, should I convert my IRA to Roth IRA, should I sell that stock or invest in a municipal bond? You do these calculations using the marginal rate.
Your next realization will be that looking at Federal tax tables may not help you understand your marginal rate. The rules are so complex that you have to model what you want to do with tax s/w. It's just not as easy as saying stuff like 'my capital gains will be taxed at 15%'. Too many phaseouts and parallel systems. You can easily think your marginal tax rate is 28% when it's really 35% or 24% etc.

Yes, I'll caveat all that. Most of that won't apply in my case, but probably will for most on the boards here.

 

[target2019]

Couldn't get through the article. Too complex.

I add 100 dollars to income when I'm through and calculate how much I'll take away if I work another hour or two. In our situation there are other factors, like self employment income.

I'll come back with the answer after a sweet nap. Lol.

 

[UpAnchor]

Yes, a common misconception that sometimes drives me nuts in that some people in the 25% tax bracket will complain so loudly about how taxes are so high and its not worth working because they earn $100k and pay $25k to the feds.

Yep, that's one of those myths I expect will live on forever. Sort of like the old, "It didn't cost me anything. I wrote it off on my taxes..."

 

[Fedup]

I've been consistently paid less tax compare to my high earning years. Even less so when I retire, well at least for a while until I get SS and RMD.


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[6miths]

Never really worried about it. Worked as hard as I wanted, took all the breaks they would give me and paid the taxes. Very thankful to live in a country where most people share the same mindset.

 

[Danmar]

Yes, marginal tax rates are often misunderstood. In Canada you generally hit the maximum income tax rate at a fairly low amount (around $200,000). For high earners it might be better to actually think of your tax rate as the max marg rate and then think of the lower rates as a little tax reduction capped at a finite amount(around $15,000-20,000). Just another way of looking at it.

 

[audreyh1]

What matters is the effective tax rate - divide your taxes owed by your AGI and you get a better idea of what taxe rate you are paying (this method excludes non-taxed income).

 

[Options]

Well that's true for income, but to get all you dividends tax free you need to stay within the 15% bracket. Also what about ACA credits and other benefits.......

+1

What matters is the effective tax rate - divide your taxes owed by your AGI and you get a better idea of what taxe rate you are paying (this method excludes non-taxed income).

This.

From the article:

Your real tax rate is your effective tax rate

When people talk about tax rates, what they’re really talking about is their effective tax rate. This is the actual tax rate you pay after you factor in everything*on your tax return: exemptions, deductions, credits and so on.

Emphasis added

As the two main factors correlating to PF longevity are taxes and fees, I am very pleased that my ETR is less than 5% for the life of my PF (something like 3.3%, IFIRC, and that's only if I don't move to a no income tax state). As others above have noted, there are many moving parts to tax management, and as Rick Ferri says, investing is easy, taxes are hard. I modeled my situation over a number of years in tax software which helped make the process easier.

 

[6miths]

Yes, marginal tax rates are often misunderstood. In Canada you generally hit the maximum income tax rate at a fairly low amount (around $200,000). For high earners it might be better to actually think of your tax rate as the max marg rate and then think of the lower rates as a little tax reduction capped at a finite amount(around $15,000-20,000). Just another way of looking at it.

Only with close proximity to the U.S. does $200,000 seem like 'a fairly low amount'! Holy first world problems Batman! And one still has to go far beyond the top marginal rate before one's effective tax rate gets anywhere close to the top marginal rate.

Of course if you are making a million plus a year, you can look at it any way you like... but I would suggest that if you are making that much income as salary that maybe it is time to spend some of it on a good tax accountant and compensation negotiator, they are both tax deductible.

 

[jkern]

If you count income taxes, employment taxes, state taxes, property taxes, sales taxes, etc. you likely pay well over 50%.

Several years ago I tried to calculate my total tax liability. After adding Income Tax, Property Tax, Sales Tax, FICA, State Disability Tax, Gas Tax, Bridge Toll (I included this as a tax), and estimating other hidden taxes. My total tax rate was about 45%.

 

[nun]

Several years ago I tried to calculate my total tax liability. After adding Income Tax, Property Tax, Sales Tax, FICA, State Disability Tax, Gas Tax, Bridge Toll (I included this as a tax), and estimating other hidden taxes. My total tax rate was about 45%.

1) Income tax.....I control my spending to stay within the 10% or 15% tax brackets.
2) Property tax.....I bough a two family in a town with lower property tax than the surrounding towns because of a diverse residential and industrial tax base, The rent more than covers the property tax.
3) Sales tax....see 1)
4) FICA.....pension, IRA and taxable account withdrawals have no FICA.
5) Gas tax.....I ride my bike a lot. I only drove 2k miles last year.
6) Bridge and road tolls.....see 5)

 

[dtbach]

I really pay no attention to tax rates. Years back I held off selling a high flying stock because it would have put me into a higher tax rate. Then it dove in value and took care of that problem for me. How fricking dumb was that!


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[RunningBum]

What matters is the effective tax rate - divide your taxes owed by your AGI and you get a better idea of what taxe rate you are paying (this method excludes non-taxed income).

It depends on why you are figuring it out. If you want to know how much you are paying in income taxes, yes. But if you are trying to decide how much to convert to a Roth IRA, in many cases the marginal rate matters. If you go over the 15% bracket with all income, in most cases you are not only paying 15% on your Roth conversion, but you've just some pushed dividend/LTCG income into being taxable at 15%, for a net 30% on that extra amount. I call it the phantom 30% tax bracket between 15% and 25%. Now, going $5 over that is not going to make a real difference, but going $10K over does because you'll pay $3K on that extra income. It would be better to spread out the conversion if possible so that you don't push divs/LTCGs into being taxable so that you don't hit that phantom 30% bracket at all.

Rarely does going into a new tax bracket actually hurt, unless you hit something like the subsidy cliff, which isn't actually a tax bracket.

Many, many years ago I worked with someone who got a 5cent/hr raise, and found that it actually did reduce her tax home pay, by something like $1. I think this was because of the withholding tables used, and I'd think it would've come out right at final tax filing time, but she actually went to her boss and told him to take the raise back.

 

[RunningBum]

I really pay no attention to tax rates. Years back I held off selling a high flying stock because it would have put me into a higher tax rate. Then it dove in value and took care of that problem for me. How fricking dumb was that!

I did something very similar. I held off on selling much of my company stock options before the dotcom bubble burst because I was moving to a state with a 2% lower tax rate the next year. I figured it was enough to buy a pretty nice car, but it wound up costing me over $1M.

I still pay attention to tax rates in general, but I make decisions like this based on the correct factors, and then try to optimize for taxes if I can--for example, tax loss harvesting or limiting gains if I'm not selling all shares. I don't let the tax tail wag the whole dog.

 

[jabbahop]

What matters is the effective tax rate - divide your taxes owed by your AGI and you get a better idea of what taxe rate you are paying (this method excludes non-taxed income).

I wonder why the irs or states don't show that at the bottom of your tax form. Your marginal rate is 28%, your effective rate is 18%. It might make people feel a bit better.


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[harley]

I wonder why the irs or states don't show that at the bottom of your tax form. Your marginal rate is 28%, your effective rate is 18%. It might make people feel a bit better.

I think it's because they don't want to start a precedent of doing something that makes sense or is helpful. They have a reputation to maintain.

 

[athena53]

I wonder why the irs or states don't show that at the bottom of your tax form. Your marginal rate is 28%, your effective rate is 18%. It might make people feel a bit better.

Or it might make them cry. You know that for most of the population the most important figure is their refund.