100% Tax Rate

[Much Fishing to Do]

Just thought this was interesting as I had wondered before if certain tax thresholds cause weird marginal tax rate results.  Generally there are phaseouts etc that prevcent this from happening.  But My sister (knowing I know finances/taxes) brought me a notice her family received from the IRS suggesting they owe about $3000.  My wife had looked at it before I had and said to the best of her understanding it basically said they had left out reporting about $3000 in dividends, and now owe about 3000.  i said this was obviosuly not the case (esp knowing it was from year their sole income earning was in school half the year) but I'd take a look.

Looking at it now I think this is actually the case.  They had (knowing they wouldnt really owe much/anything that year) done their taxes themselves that year with turbotax and left out a 1099 form from their main investments that showed $3000 in dividends. From what I can tell this plus a little dividend amount they did report made them over the investment income threshold so they do not qualify for the EIC turbotax had applied that was apparently worth about $3000. 

Just thought it was interesting this one hit that, I wonder if it cold have been greater than 100% (not sure how what they received was calculated)

[seattlecyclone]

Depending on how you look at it, some income was charged at way more than 100% in this case. The EIC has a strict limit on investment income. If you're under the limit by $1, you can claim the full amount of the credit. If you're over by $1, you get no credit. Most of these dividends didn't affect their taxes by much at all, but there was that $1 that bumped them over the limit, eliminating $3,000 in credits. You could easily argue that particular dollar was taxed at something like 300,000%.

[Babybalrog]

Google "welfare trap" and you get lots of examples like this. The phase out and implied marginal rates of take credits, and deductions can routinely drive marginal tax rates above 100%. That's the problem with our overly complicated system. There is a classic waterfall chart which is the first image when you google. Sums it up quite nicely.

[ontheway2]

I have not experienced a 100% rate, but this is an issue I have with a lot of people that simply think mid-lower income should contribute to Roths. Although I am in a very low tax bracket, funds put in a roth vs traditional IRA are taxed around 45% when you take the savers credit and EITC into account.

Does the 3k they owe include any fees or penalties?

[teen persuasion]

Could be a good bit more than 100%.  Max EITC is $6400ish, but the investment income cliff is at $3500.  Add in the lost state EITC (my state matches federal EITC at 30%, so another $1900ish max).

[frugalnacho]

I've run into a similar cliff with the tax savers credit.  Earning just a small amount over the limit pushed me over a cliff that reduced my credit substantially.  It was effectively over 100% taxation.

[ontheway2]

I've run into a similar cliff with the tax savers credit.  Earning just a small amount over the limit pushed me over a cliff that reduced my credit substantially.  It was effectively over 100% taxation.

Yes! When I was able to get in the 50% credit, it was a huge deal to not go $1 over and drop to the 20% (2k vs $800). I'm now in the 20%, so dropping to 10% is not as big of a deal although something to try to avoid (400 vs 200)