On Jul 28, 5:17*pm, joetaxpayer <joetaxpa...[at]nospam.com> wrote:
- quote -

Quick followup on this issue. I found a pretty good way to achieve
some salary deferral (legally). My employer allows me to take time
without pay. So for the rest of the year, I plan on using that option
instead of taking any vacation time. My vacation time never expires
and there's no limit on how much I can accrue. So even if I don't use
it, they'll pay me out if and when I leave the company.

--Bill

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On Jul 28, 2:40*pm, Mark Bole <ma...[at]pacbell.net> wrote:
- quote -

Fortunately, the math doesn't care about sensationalism. The marginal
tax rate is what it is.

- quote -

Not really. It doesn't alter the fact that $40K worth of income would
be taxed at a very high rate. However, any FURTHER income would not
be taxed at that really high rate.

- quote -

That's kind of funny, since he was a foster child... but I digress.

Again, I disagree with your conclusion. In order to discourage
adoptions for people in my tax bracket, the law would have to pile on
extra taxes for adopting. That's clearly not the case. It simply
creates a higher marginal tax rate. My taxes couldn't be HIGHER
because we adopted. They could only get lower.

There's actually a really neat graph you could draw to demonstrate
this concept. I'll attempt it in ASCII art:

| ......
| ..........*****
T| ............... *****
a| *****
x| *****
| *****
| *****
+----- ^ AGI ^
| |
Begin End
Phase Phase
Out Out

The upper line (dots) represents your tax liability without the
credit. The lower line (stars) represents your tax liability with the
credit. At the point at which the phase out ends, the two lines are
equal. At every point left of there, your taxes WITH the credit are
lower, but the slope is higher. Ergo, a higher marginal tax rate.
(Coincidentally, the difference between the two lines at the beginning
of the phase out is the value of the credit.)

- quote -

I don't think that's an absurd conclusion at all. If you DON'T
include credits not received, how can you ever have an apples-to-
apples comparison? Furthermore, you're throwing in the average tax
rate here, which is not really relevant to the topic of discussion.
We're focusing on marginal tax rate. Does the child tax credit phase
out affect my marginal tax rate? Personally, no, but it would if my
AGI put me inside the phase out range.

--Bill

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joetaxpayer wrote:
- quote -

I should have added -- this is a completely on-point thread at the
moment, I'm in the midst of a project where the main decision is how
much (if any) to borrow for a recent retiree's home, where they may (but
won't necessarily) fall smack-dab in the that range where SS becomes
increasingly taxable. I think the tax gods for BNA Income Tax Planner at
moments like this, it would be impossible to do otherwise.

Incidentally BNA lists at the bottom of the standard summary report
three figures: "Marginal Nominal Federal Rate," "Marginal Federal Rate
with Phaseouts," and "Marginal Resident State Tax Rate." Curiously,
while the software calculates the taxable SS component accurately,
neither of the marginal fed rates is accurate on the report with respect
to the increasing tax on Social Security. It really only shows your OI
tax bracket (or the AMT rate if you're in AMT). I'd call that a bug.

For a retiree, I usually spare the client the jargon-heavy reports, I
think they only confuse things if you don't know what each line means.
But I'm getting to the point where I open a BNA file on almost every
client with a taxable account, the outcomes are too unpredictable.

-Tad

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Tad Borek wrote:

- quote -

It's a wonder we humans ever started communicating at all. I like your
choice of wording above, and will adopt it.
Joe

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joetaxpayer wrote:
- quote -

One thing about this phantom rate you're discussing (someone mentioned
this I think) is that it's entirely dependent on what variable you're
changing as you generate the points in your graph. And given that a
typical "real" scenario is a combination of factors, it's almost
impossible to speak in terms of a phantom rate for anything but a
single, incremental change in some variable.

I think you added in an ever-larger IRA distribution in your web site
example, which generates one set of rates and inflection points. But you
would see quite different shapes and rates for each of the following
add-ins, especially if (as is usually the case) it's a mix of them:
tax-exempt interest, US government interest, interest, QDI,
long/short-term capital gains, capital losses, salary, self-employment
income, annuity income, pensions, SS, etc. Plus, you'd need to overlay
AMT and AGI-driven phase outs on all of this, factoring in the exact
types of deductions and credits on the return (medical expense
phase-outs, misc itemized phase-outs, etc). An infinite number of curves
for an infinite number of scenarios.

So talking about a "phantom rate" becomes difficult, because it's a
moving target depending on what you're choosing to change. A bit like a
phantom, sure, but more like a haunted house full of them, in different
shapes and sizes.

For the issue you're discussing, I simply say: "there's a range where
more and more of your Social Security becomes taxable, based on your
total income for the year." And then: "you're well above that range so
this isn't a factor in your planning" or "you're in that range, so we'll
be careful in managing your income each year, and make decisions
accordingly." Marginal, effective, phantom, nominal, bracket
rate...doesn't the jargon just confuse things? Heck half the people on
this thread don't seem to accept standard terms like "tax bracket"...

Regarding your 80+ year old...with MRD of $33k you're talking about
someone with a $300k+ IRA, correct? That I think illustrates the policy
argument for the current scheme of Social Security taxation - reflecting
the evolution of SS into a safety net for those lacking ample qualified
assets, rather than an annuity-like entitlement enjoyed equally by all
who contributed. I don't want to debate the pro/con of that, but I
believe that's the direction these entitlements are headed, given the
funding shortfalls. Thems who gots, pays the tax.

-Tad

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On Jul 28, 5:17*pm, joetaxpayer <joetaxpa...[at]nospam.com> wrote:
[snip]
- quote -

Just some more thoughts on the topic .... The marginal rates do
approach the bracket rates, eventually. A 60k wages total may be taxed
at 17%, but if the person has 300k of LT cap gains, the same 60k wages
will likely be taxed at 28%. Until the max brackets are reached in all
categories of income, income is taxed as if it were all "married
filing jointly" <grin> as opposed to "divorced" <grin> . Proper
allocation would not attribute the additional 6.6k (60k x (.28 - .17))
tax due as a tax on LT cap gains, but as a progressive tax on the
income category of wages.

A 300k wages total may be taxed at 28%, and if 300k of LT cap gains
are added, the cap gains should be taxed at approximately 15% under
current law. (The income is now "divorced".) It would not be good
accounting theory to say that the 300k wages was taxed at 15% and the
LT cap gains at 28%.

Deductions and credits are, apparently, considered a kind of "tax
break". Their phase-out does accelerate the progression of the
marginal rate towards its eventual match to the tax bracket rates, but
does not change the brackets themselves. I believe the proper
accounting theory would be to allocate the increase in tax due not to
the income, but to the phase-out of "breaks."

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On Jul 28, 3:51 pm, Douglas Johnson <p...[at]classtech.com> wrote:
- quote -

I concur. I duplicated your results with a larger
differential, just to be sure the large percentage
was not an illusion due to the small number.

I stand corrected.

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Mark Bole <makbo[at]pacbell.net> writes:

- quote -

Really? Looks to me like that's what Form 1040 does.

It's somewhat meaningless to say "what's the marginal rate on taxable
income" because BY DEFINITION that rate will be one of the "official"
tax bracket rates.

To compute your marginal rate you need to compute the tax on
your current situation. Then you need to increase your gross
income by, say, $200 and compute your tax in that new situation.
Then subtract and divide by the $200. How you increase your
gross income for the calculation is up to you -- but you should
increase the component(s) of gross income that you want to find
marginal rates for.

Note that increasing your gross by $200 may well increase your
taxable income by MORE than $200 (because of phaseouts and the
like). Which is of course why the marginal rate is higher than
the "advertised" rate in those cases when it is.

--
Rich Carreiro rlc-news[at]rlcarr.com

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joeu2004 <joeu2004[at]hotmail.com> writes:

- quote -

It shouldn't be rhetorical, because the answer is clearly,
obviously, and empirically, "Yes!".

- quote -

Because they are.

If you're in the "advertised" 28% bracket, and have deductible medical
expenses, and your gross income increases by $100, your tax will
increase by $30.10, *not* $28. So your marginal rate is 30.1%.
Period. Even though you're in an "advertised" tax bracket of 28%.

(Rate is 30.1% because $100 increase in gross income reduces
deductions by $7.50, so taxable income increases by
$100 + $7.50 = $107.50 and 28% of $107.50 is $30.10).

If you earn $100 more and your tax increases by $30.10, I can't see
how you can claim the actual tax rate you experience on your last
dollar is anything other than 30.1%.

--
Rich Carreiro rlc-news[at]rlcarr.com

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Rich Carreiro wrote:
[...]
- quote -

I'm not aware of any tax law that specifies how to compute a tax on
gross income.

There are of course laws which specify how to add up gross income,
adjust it, deduct from it, and compute tax on the remaining taxable
amount. Then a bunch of additional stuff is calculated, resulting in a
refund or balance due.

The most technically correct description I can think of for what is
being discussed here is the "marginal Form-1040-Line-72-minus-Line-63
rate".

-Mark Bole

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On Jul 28, 12:59*pm, redmo...[at]sprynet.com wrote:
- quote -

Huh!? Try Googling "define: marginal tax rate". Just a sample:

* Marginal tax rate refers to the highest published tax rate at
which a taxpayer’s last dollar earned is taxed.

* The combined federal, state, and local tax rate applied to
the next additional dollar of income. For example, if your
federal tax bracket is 28%, and your state tax rate is 5%,
when you earn another dollar of income, it would be taxed
at a 33% tax rate.

* The current US income tax system is based on this rate.
The amount of tax imposed on an additional dollar of income
is the way the US tax system levies it's [sic] tax.

* The income tax rate at which the last dollar of your income
is taxed.

Do you think the "tax bracket" is anything other than the
"income tax rate at which the last dollar of yoru income is
taxed"?

That's a rhetorical question.

But in "joetaxpayer's" defense, I will note that I stumbled
across an online CCH calculator [1] that computes "your
current tax bracket and your marginal tax rate", as if to say
that these are different. Moreover, the explanation of the
calculator results explains things the way that "joetaxpayer"
does, to wit: "At higher incomes, exemptions, many deductions
and many credits are phased out. This increases your tax
bill and your marginal tax rate". When I entered some
hypothetical numbers, sure enough: it shows a tax bracket
of 28% and marginal tax rate of 28.56%.

I have not crunched the numbers to see where the 28.56%
comes from. I think what they mean is: with the phase outs,
more of your income becomes taxable. But I am still skeptical
of and take issue with the assertion that the "marginal tax
rate" (i.e. tax rate applied to additional dollars of income)
increases. For example, when everything is phased out,
mathematically the tax rate on additional dollars falls back
to the tax bracket rate -- albeit perhaps a higher tax bracket
than if there were no phase-outs.

Nevertheless, I must concede that this is CCH talking.
"When CCH talks, everyone listens", to paraphrase an old
commercial (Merrill Lynch?).

-----

Endnotes:

[1] http://www.finance.cch.com/sohoAPPLETS/TaxMargin.asp

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Mark Bole wrote:

- quote -

Agreed. The SS chart was my first observation of the phantom rate and I
(perhaps mistakenly) made a connection.

- quote -

Agreed here too, although more because there's little if anything Bill
can do to change his situation. If income deferral were a legal,
legitimate option, he'd be better off for having shifted income from 08
to 09.

- quote -

Right, but he'd have still been subject to that phantom rate. Back to my
SS people, if they need the withdrawal due to RMD or just needing the
money, they should take further withdrawals and/or Roth conversion to
fill up the 25% bracket. They may then avoid the phantom rate for a few
years after that.

- quote -

Absurd, yup.

- quote -

In a strange way, I think these credits that I can't benefit from are
all examples of this phenomenon, and I recall years ago a chart in
Barron's that, similar to my SS chart, tracked all of the
credits/phaseouts in effect at that time. Even in pre-retirement there
were a series of odd phantom rates as income rose. In general, the only
ones that concern me are those that are within my range, i.e. the rates
I'd hit or miss depending if I am having a 'good' year or have gains or
losses that are impacted. My LT cap gain rate is 22.5%. That rate is
real, whether or not it impacts my decision to buy or sell a stock.

As always I appreciate your feedback, and I'll probably be more careful
referencing this topic.
Joe

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On Mon, 28 Jul 2008 08:00:31 -0500, joetaxpayer
<joetaxpayer[at]nospam.com> wrote:

- quote -

I think marginal tax rate is a legitimate concept to describe the
phenomenon you are discussing. It should not surprise anyone that
marginal tax rate and tax bracket are two different things.

To be mathematically more precise one might prefer to calculate the
marginal effect on a much smaller increment, in the ideal case $1. Use
of the term "rate" suggests the spirit of the mathematical derivative.

I also think that trying to digest tax computations as a rate applied
against income can lead to much confusion. Sometimes the result is
simpler and more clear to simply compare the total tax across
different income scenarios and not struggle with where in the tax
computation the difference arises.

One should also note that the marginal effect of an increase in income
might be quite different depending on the source of the income

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joetaxpayer wrote:
- quote -

Actually, I like your use of the term "phantom", meaning "something
existing in appearance only" [Merriam-Webster]. There might be some
clarity in terminology by referring to "statutory" vs. "effective"
marginal tax rates, but it's still a problem to call something a tax
that really isn't.

- quote -

(Joe, your favorite example using Social Security is a little different
than the Bill W's tax credit example so keep in mind I'm addressing both
in the next few paragraphs.)

Tell Bill W that the higher his income goes, the more he loses out on
government-subsidized benefits for low-income persons (a.k.a.
means-tested transfers).

Tell him also that some, but not all, of these transfers are
administered by way of IRS tax forms. "As a general rule for policy, tax
deductions make most sense for items that represent reductions in
ability to pay tax, such as casualty losses. Credits are more
appropriate for subsidies provided through the tax system."
[www.taxpolicycenter.org].

Finally, (for Joe's clients), tell them that by default, they get a full
"deduction" (exclusion from taxable income) for their Social Security
benefits. However as their income rises, the deduction phases out, but
never below 15% of the amount received.

With this understanding, if the taxpayers write to their elected
representatives, at least they'll be addressing the correct issue
(means-tested transfers via tax credits and deduction phase-outs, not
tax rates).

In general, there are at least two problems with trying to inject the
notion of "marginal tax rate" into these situations:

1) Sensationalism -- look at the subject of the previous post. Instead
of focusing on the planning issue (how to maximize the benefit of an
adoption credit), it was clearly worded to spark some outrage or at
least surprise at the tax laws -- gee, how could my marginal tax rate be
so ridiculously high?

2) Reductio ad absurdum

- (absurd conclusion #1) Bill W should strive to *increase* his gross
income sufficiently to get above the phase out level. This will cause
his effective marginal tax rate to come back down to what it was before,
problem (as presented) solved.

- (absurd conclusion #2) He should have taken in a foster child instead
of adopting, since it was the adoption event that increased his marginal
tax rate so drastically (the tax law was designed to discourage
adoptions by people in his income range).

- (absurd conclusion #3) All credits not received should be treated as a
tax paid, as Bill W claims (remember, he says that every dollar of
income is costing him an extra 29 cents in tax). Therefore, the stimulus
rebate, Earned Income Credit, child tax credit, and so on all *raise*
the average tax rate of all higher-income taxpayers who aren't eligible
to receive them.

-Mark Bole

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On Jul 28, 9:00*am, joetaxpayer <joetaxpa...[at]nospam.com> wrote:
[snip]
- quote -

[snip]> Joe

Nice chart, nice webpage, interesting article. I don't see anything
wrong with "phantom tax bracket" - I rather like it! You might write
the IRS and ask them if they have a name for it - I'm sure they are
aware of it, and may have a creative name made up themselves (an IRS
gal once referred to their automated answering system as "1-800-
HEAVEN", for example).

I ran into a situation (involving a phase-out tax shelter amounts)
where the marginal rate on some $2,000 came up much higher than the
brackets, but my overall tax rate matched the brackets. I actually
admire the IRS - it's tax laws I'm not best friends with :-)

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joetaxpayer <joetaxpayer[at]nospam.com> writes:

- quote -

"Marginal rate" or "marginal tax rate". I personally use
"nominal rate" to refer to the 10/15/25/28/etc. official rates.

The definition of marginal rate is quite simple:

T(I + deltaI) - T(I)
Marginal rate = --------------------
deltaI

In other words, you compute what your tax is on your current gross
income, compute what your tax would be on your current gross income
plus an increment, subtract the former from the latter, then divide by
the increment. A common deltaI would be $100. $200 may be better as
it spans more "buckets" in the tax tables, for those whose income
requires them to use the tax tables.

"Effective rate" is probably also OK in theory, but I've also seen it
used (mistakenly, IMHO) to mean the same thing as "average rate"
(i.e. total tax divided by total gross income) and so I prefer the use
of "marginal rate", especially given the well-known meaning of
"marginal" in economics, finance, and accounting.

(And yes, if taxes were a function of a continuous variable instead of
a discrete one, you'd take the limit of this as deltaI goes to zero
and the marginal rate would simply be the derivative of the tax
function, evaluated at your gross income level .

--
Rich Carreiro rlc-news[at]rlcarr.com

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In the current thread discussing Bill W's adoption credit, a number of
people are saying that he (and I) are incorrect to call his current
situation a total 67% marginal rate.

In an article I wrote some time ago, titled "Social Insecurity" at

http://www.joetaxpayer.com/ss.html

I created a chart showing the increase in federal tax due for each $1000
increment of income. This was done with an eye toward finding the tax
impact of IRA withdrawals on top of $15,000 social security income for a
65+ yr old woman. In her case, the withdrawals from the IRA were
controllable, and the rest of her tax situation, simple.

For her, I concluded there was an effective rate of as much as 46.25% on
her withdrawals as she passed into the range where the social security
became taxable.

My question - I've referred to this 46% bracket as a "phantom tax
bracket". If that phrase is incorrect, what is it called? I'll accept
that the term "marginal tax bracket" may be the 10/15/25/28 brackets as
referenced by the tax charts we're all used to seeing. But when I sit
with turbo tax and my senior clients, what words do I use to describe
the fact that for them, the next $1000 is taxed at something greater
than those 'neat' few marginal rates?

Finally, what makes Bill's situation any different from the above, aside
from the fact that his seems to be pretty unmanageable? Had he been
older, 59-1/2+, we'd be answering him a bit differently, no? Bill - just
don't take that huge IRA distribution this year, reduce it to stay under
where the credit phaseout starts..... and he'd take $40K less out.

As always, if I am misusing a term, I'm always seeking to be set straight.
Thanks,
Joe

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