Author Topic: Nasty Tax Cliffs  (Read 18387 times)

dragoncar

  • Walrus Stache
  • *******
  • Posts: 8520
  • Registered member
Re: Nasty Tax Cliffs
« Reply #50 on: October 08, 2015, 09:02:49 PM »
Quote
I fail to see how a 56% marginal rate is possible, but I'd love to see an example.

As Jeremy alluded (and discussed in more detail in his blog link):
There is a Social Security Tax Torpedo
It phases in, but for people on the edge of income bands it can result in high phantom marginal rates
(see marginal rate charts in this post: http://www.gocurrycracker.com/social-security-tax-torpedo/)
Social Security taxation can enforce extremely high marginal rates on relatively low incomes.  E.g., for your typical single 64 year old West Virginian getting $2K/mo in SS and withdrawing $3K/mo from a tIRA, the real marginal rate on another $100/yr IRA withdrawal is 57%: (25% federal + 6% state) * ($1.85 taxable per $1 increased ordinary income) = 31% * 1.85 = 57%

Granted, the fraction of all people who meet those requirements is small, but it's an example.  ;)

Wait, so the SS torpedo is taxed at a 185% marginal rate?  That cray cray

MDM

  • Walrus Stache
  • *******
  • Posts: 9412
Re: Nasty Tax Cliffs
« Reply #51 on: October 08, 2015, 09:16:22 PM »
Wait, so the SS torpedo is taxed at a 185% marginal rate?  That cray cray
Somewhat of a semantics issue.   The tax brackets in this case are 25% federal and 6% state.  Each extra dollar of ordinary income is taxed at those rates.  The extra ordinary income, however, causes more of the SS income (in this range, $0.85 of SS for every extra $1 of ordinary) to become taxable, and that $0.85 is also taxed at 25% and 6%.

Cathy

  • Handlebar Stache
  • *****
  • Posts: 1046
Re: Nasty Tax Cliffs
« Reply #52 on: October 08, 2015, 09:32:06 PM »
Wait, so the SS torpedo is taxed at a 185% marginal rate?  That cray cray

It's actually possible to construct significantly higher marginal rates than this. Suppose that you are a citizen or resident of the United States and your only income during the taxable year is $399 in "net earnings from self-employment" (as defined in 26 USC 1402(a)). Your total tax due will be $0 because no self-employment tax applies if the "net earnings from self-employment" are under $400. 26 USC 1402(b)(2). Now suppose you gain a single additional dollar in "net earnings from self-employment". You are now required to pay $61.20 in tax (ignoring tax credits and other such complications for the purpose of this discussion). This is a marginal rate of 6120% for the last dollar of income earned.
« Last Edit: October 08, 2015, 09:46:31 PM by Cathy »

teen persuasion

  • Handlebar Stache
  • *****
  • Posts: 1056
Re: Nasty Tax Cliffs
« Reply #53 on: October 09, 2015, 06:57:33 AM »
Quote
I fail to see how a 56% marginal rate is possible, but I'd love to see an example.

You're right, I played around with this a bit and when I dug into it, I came up with a 51.85% marginal rate. Here's how I got there.

339k total income
247k AGI

The AMT tax rate is normally 28% and is assessed on the disallowed deductions- state tax, real estate and school taxes in my case. But, because we're in the phase-out stage, the rate increases from 28 to 35% on the disallowed deductions until the phase outs are exhausted, at which point the marginal rate drops back to 28%. For an explanation of this see http://www.amtadvisor.com/AMT_Exemption.html, or check out the calculation on line 29 of Form 6251. I filled out two 6251's with a difference of $1000 in income, and this resulted in an increase of $65 in the AMT. So, net is 6.5% to the marginal rate at this point in the phase-outs. This form is complicated but the key seems to be in the line 29 calculation.

The exemption loss is 2.6% (you showed a good example there, thanks!)

33% federal bracket
6.85% NYS tax bracket.
2.9% Medicare tax on self employment (see 1040 SSE - why is this shown as 2.35% in some calcs?).
6.5% AMT
2.6% exemption loss
---
51.85% marginal rate

Thanks, that's totally plausible.  But I still wouldn't call that a "cliff"... I found a good graph here:



http://taxfoundation.org/blog/there-are-more-marginal-income-tax-rates-advertised

Obviously it can't account for different deduction amounts.  And I couldn't find one that shoes total effective rate by income, which is really what we mean when we (I?) say "cliff" -- i.e., one extra dollar earned has >100% marginal tax rate.

I obviously didn't look close enough at this graph when it was first posted.  The EITC phaseout rate varies based on how many children are claimed.  The 7.65% listed in the graph is for 0 children.  For the other end of the EITC levels (3+ children) the phaseout is roughly 21%.  Add the 10% fed rate and you get 31% at fairly low income levels.  Since my state matches EITC at 30% the phaseout at the state level is another 6.3%, and state tax at about 4% for a total of ~41.3%.

dragoncar

  • Walrus Stache
  • *******
  • Posts: 8520
  • Registered member
Re: Nasty Tax Cliffs
« Reply #54 on: October 09, 2015, 02:35:15 PM »
Wait, so the SS torpedo is taxed at a 185% marginal rate?  That cray cray

It's actually possible to construct significantly higher marginal rates than this. Suppose that you are a citizen or resident of the United States and your only income during the taxable year is $399 in "net earnings from self-employment" (as defined in 26 USC 1402(a)). Your total tax due will be $0 because no self-employment tax applies if the "net earnings from self-employment" are under $400. 26 USC 1402(b)(2). Now suppose you gain a single additional dollar in "net earnings from self-employment". You are now required to pay $61.20 in tax (ignoring tax credits and other such complications for the purpose of this discussion). This is a marginal rate of 6120% for the last dollar of income earned.

Typical tax legislation killing job creation.  Just think of all those people who are shutting down their business at $399 just to avoid hitting $400 in annual profit!