Do you know your marginal tax rate? You might quickly do an online search and point me to the federal tax schedule like this one from H&R Block. On top of that, you might add your state income tax bracket. If you filed tax by yourself last year, or you read what your tax preparer did for you, you should be answer this question pretty easily.
For the most of this year, I am always using 25% as my marginal tax rate in different analysis of financial decisions. The State of Washington has no state income tax, so my federal tax bracket is, by most definition, my marginal tax rate.
Yes, it is pretty straightforward, but ...
I just realized that my marginal tax rate is different from what I thought.
These days, I am studying tax topics once again. I believe it is always to think ahead and see if certain actions can be taken to improve one's financial status. In terms of tax, because many possible financials moves have a deadline of December 31 to affect this year's tax, October is the right time to do some little planning.
Today I am checking out the topic of Child Tax Credit. This is the $1,000 per child credit that directly offsets your tax bills. While I had been counting on this $1,000 until now, today I noticed that this benefit will start to phase out when the family's adjusted gross income (AGI) tops $110,000 (see H&R Block's tax chart) -- with my wife's extra income, we will certainly top that figure by end of 2004.
Now, once the $110,000 bar is reached, Child Tax Credit will decrease by $50 for every $1,000 AGI above $110,000, and the entire $1,000 (for my only child) will disappear if our AGI hits $130,000 (we will not -- for this year). Between $110,000 and $130,000, this phase-out arrangement essentially represents an extra 5% tax on additional income. Adding my 25% tax bracket, our marginal tax rate is now 30%.
Next year, if my wife wants to keep working for the full year, our AGI might be in the range of $150,000 even if we exhaust all 401(k) and Flexible Spending Account contributions. After some forseeable deduction and exemptions, this will, for the first time, put us into the 28% tax bracket. What's more, above $142,700, itemized deduction phase-out mechanism is putting another 3% "wealth tax" on additional income, so our margin tax rate can be as high as 31%.
The above analysis does not even consider that each additional dollar in job income (instead of "passive income") is also subject to 1.45% Medicare tax. Adding this, I can only keep less than 70 cents for every dollar I bring home.
It is no longer an easy exercise to figure out marginal tax rate now.