Is my marginal tax rate really 67.53%?

I feel your pain. I relate the story of how my 80+ yr old woman hits a

46% bracket by taking an IRA distribution of just $33K.

Does your company also have a FSA (flex spending account) to cover medical? There's $5K that you are allowed to turn on due to change in family situation, the adoption counting as such.

How about paying property tax ahead of schedule? My tax guy at town hall said he'd be happy to take my money as far ahead as I wanted to pay. Maybe yours will take your 2009 tax, and it will be pennies (well 33 of 'em) on the dollar to you.

Make your January mortgage payment in mid-Dec to be sure it's credited in 2008.

If you are a donator to any charity or house of worship, make those donation in 2008 and include extra to cover 2009.

Ask both your employers if they can help. I had a similar issue years ago, and called the payroll dept. They agreed to shut me down for a month, December, and then cut me the check in January with a 'sorry for the glitch' letter, but it stayed off the prior year W2.

Adjust your state W4 withholdings to have a bit too much withheld. Too much can be an issue, but a certain amount will help you, and no problem.

I hope that helps. I tip my hat to you and the misses. I've always felt there was a special place in hell for people who wallpaper over brick, and a special place in heaven for those who adopt special needs children.

Joe

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And don't forget to add, as a percentage, all the other deductibles that you cannot claim because of AGI caps. Add them all together, and you probably have a 100+% marginal rate, by your way of thinking.

In short, no, your math is not correct. You cannot take the unqualified adoption credit and add it as perentage to your (real) marginal tax rate and get any kind of meaningful number.

(If you want a meaningful number, consider this approach. First, figure your total tax as a percentage of taxable income. Then figure your total tax less the credit you wish you qualified for, again as a percentage of taxable income. The difference is the "cost" of the unqualified credit as a percentage of taxable income.)

That is not really your point. But I think you are making yourself feel more miserable than necessary by the "innumerate" way you are trying to spin the numbers.

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The adoption credit basically means the government will subsidize the cost of the adoption dollar-for-dollar off your taxes, up to a certain amount, unless you are a high-income taxpayer. And, as you mention, for a special needs child, you can get the subsidy even if you didn't spend anything at all out of pocket.

By definition, a "special needs" adoption is one where "assistance is provided to the adoptive parents" (Form 8839 instructions). The fact that you had no expenses means you already got a pretty good break, no?

This part of the discussion really should go in the misc.taxes.moderated group, but your terminology is misleading. Your tax rate is based on, and applied to, your taxable income. Credits, if any, come *after* the tax rate is applied. (Really, why don't you post over there, I'd be curious to see what others say).

Yes, you are losing the benefit of a credit due to high-income limitations, just like you probably lost most or all the stimulus rebate payment -- but I don't think it's accurate to say your (marginal) tax rate somehow went *up* just because you completed an adoption, or didn't get a stimulus rebate.

He said they had no expenses, and I don't think FSA's (section 125 cafeteria plan) cover adoption costs. Only payments from qualified employer adoption assistance programs can be excluded from income.

Without looking it up, I believe you can only deduct property tax that you were legally liable for, so it won't do any good to pay more than what you've been assessed by the end of the year (which of course could include tax for part of the following year, just not multiple years).

What's worse, while all your suggestions about increasing itemized deductions may help the current year's tax bill, they don't do a thing to reduce the modified AGI (adjusted gross income), so they don't change the phase-out calculation for the adoption credit at all. (Another reason why "marginal tax rate" terminology does not apply, since itemized deductions *do* factor in to your taxable income).

That could be problematic, non-qualified deferred compensation might still be taxable when earned, not when paid. You might be asking your employer to put itself at risk.

See above about AGI vs. itemized deductions. (Joe, I know you know this, I assume you were just in a hurry to post, especially since with the moderators on vacation, only the "regulars" can post anything anyway, so we're just talking amongst ourselves).

I agree, at least about the heaven part! ;-) The adoption credit is pretty rare AFAIK, but can be very valuable (just not for higher-income taxpayers). It is one of the rare personal credits that actually has carry-over provisions if you can't use it all in the first year. Also, don't forget to check your state rules, they may have a benefit that is determined differently from federal rules.

-Mark Bole

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joeu - I didn't run the numbers, but Bill's post and his math stood to reason, passing the 'napkin' test. I'll trust he knows the credit phaseout. If that last $40K of income costs him the whole credit, there's the equivalent of a 29% increase to his marginal rate. If his tax rises $26,800 with his last $40K worth of income, then indeed, that's his marginal rate. In my social security post, I refer to these rates as "phantom" because the official rates are lower than that of course. One can debate that 'marginal' references the tax on the last $100 you make. I'd not get caught up in those semantics. Sorry, total tax as % of total income is not the topic here. It may be of anecdotal interest, but it's not relevant at all to Bill's plight.

Joe

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Thanks, Mark. Right you are. I was distracted, and blew it on that reply.

Joe

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I don't see why not. If I make one more dollar, my tax bill will go up by 67.53%. Conversely, if I make one less dollar, my tax bill will go down by 67.53%. Is that not the very definition of marginal tax rate?

Ouch. That's an ironic twist of fate: the mathematician being called innumerate.

On the contrary, I don't feel miserable at all. Our total tax rate this year is astonishingly low. So I'm not complaining about our taxes. However, our ultra-high marginal rate is a somewhat unique situation. I tend to think of it as an opportunity to employ some serious financial planning. Hence the reason I turned to misc.invest.FINANCIAL-PLAN.

--Bill

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Bill Woessner wrote: [...]

You asked whether your notion of marginal tax rate was correct, and got at least two nays.

Are you really asking, "how can I reduce the impact of income phase-out on the amount of my adoption credit"?

Answer: reduce your AGI, this is basically the front page of your Form

1040. Examples: Pay some alimony. Incur moving expenses for a new job. Start a business and lose money. Sell some securities at a loss. Cash in some bank CD's and pay an early withdrawal penalty.

-Mark Bole

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A deductible expense or credit can reduce your tax and your effective marginal tax rate, but being unable to claim that cannot increase your tax rate.

If you are in the 25% tax bracket without the tax credit and your taxable income increases by $100, you will pay $25 more in taxes [1]. Obviously that number is not changed by the fact that you cannot take the adoption credit. (x - 0 = x.)

To make the point clearer, let's crunch the numbers that you offer.

If you are in the 25% tax bracket, your total 2008 tax before credits will be between $8963 and $25,550 [2]. You do not provide sufficient information for us to know where you fall in that tax bracket [3]. Suppose you fall midway -- $17,256. If you could claim the full $11,650 tax credit in

2008, your total tax liablity would be $5606. That would put you into the 15% bracket.

So you could say that the tax credit reduces your marginal tax rate by "10%" (really, 10 percentage points). In a twisted way, you might say that it increases your marginal tax by 10%; but that is 10% up from 15%, not 25%. Either way, your marginal tax without the tax credit remains at 25%.

I think it is clear that you're saying that your tax bracket is 25% __before__ credits. After all, you computed 67.53% by adding 29.13%, the mistaken increase in the marginal rate, to 25% (plus 7.65% FICA and 5.75% state tax).

But arguably, suppose you mean that the tax credit would put you into the 25% tax bracket. At most, that means that your tax before the credit would be $37,200 ($25,550 plus $11,650). But that means that your marginal tax rate is only 28% without the tax credit [4].

In that case, you might say that failing to be able to take the tax credit increases your marginal tax rate by 3% (up from 25%, not 28%). But your marginal tax rate without credits is still 28%.

"Joetaxpayer" argues that this a question of semantics, namely your meaning of the term "marginal tax rate". But your mistaken example above clearly indicates that you are referring to the term as it is used by financial professionals, namely: the percentage of the next $1 in taxable income that comprises the additional tax.

I have shown that is not what the 29.13% represents. You cannot add apples to oranges unless you want to make "fruit salad" :-).

In conclusion, adding your figures for FICA and Virginia tax rates puts your total marginal tax rate without the credit at either 38.4% or 41.4%, depending on interpretation [5].

QED.

-----

Endnotes:

[1] The additional tax of $25 per $100 of additional taxable income assumes that additional taxable income does not put you into the 28% tax bracket. [2] I am assuming that you file MFJ. Generally, that is a requirement in order to claim the adoption credit, athough there are some exceptions. [3] You say that your AGI is "in the middle" of the range between $174,730 and $214,730; that would be $194,730. If your tax bracket before credits is 25%, your 2008 taxable income is between $65,100 and $131,449. The difference is your deductions and exemptions: between $63,281 and $129,630. [4] The 28% tax bracket covers taxable incomes between $131,450 and $200,300. The computed tax is between $25,550 and $44,828. [5] That assumes a maximum FICA rate of 7.65%. That is the correct marginal FICA rate if only one of you works and your 2008 wage income is under $102,000, or if both of you work and both wage incomes are under that amount. Your marginal FICA rate is only 1.45% if only one of you works and your wage income is over $102,000. Otherwise, your marginal FICA rate is a weighted average of 1.45% and 7.65%.

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And of course, FICA applies only to additional taxable income due to income subject to FICA (e.g. wage income). It does not apply to other sources of additional taxable income.

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This second dip of the stock market can be a great opportunity to realize tax losses. This doesn't have to be a disinvestment; you can sell and do a "not quite wash" purchase of similar but not equal securities. This can be especially helpful if recent market turmoil made you sell securities with gigantic looong term gains, then bought back into something new during the latest sucker rally.

Buying something equal would trigger the screwy wash sale rules that you want to avoid. Buying something very different may expose you to hitting the crest of one wave vs the trough of another sector which can double count against you in the cycles. But trading into securities of the same sector/cycle can be a plus, because you can probably find something you like better anyway (while harvesting tax losses of the sold one).

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We might "say" that. But a mathematician ;-) would be quick to point out that even that is not correct. The marginal tax rate remains 25%(!). That is, the next additional $100 in taxable income will increase the total post-credit tax by $25, not by $15 [1].

For example, if your pre-credit tax is $17,256, your

2008 taxable income is $98,272. If your taxable income increases by $100, your pre-credit tax is $17,281, which is reduced to $5631 with the $11,650 tax credit, still $25 more than your previously computed post-credit tax.

Proof:

Post-credit tax on $98,272: (98272 - 65100)*0.25 + 8963 - 11650 = 5606

Post-credit tax on $98,372: (98372 - 65100)*0.25 + 8963 - 11650 = 5631

QED.

PS: My previous errata was posted out of order. I will repeat here for clarity.

Previously I wrote:

And of course, FICA applies only to additional taxable income due to income subject to FICA (e.g. wage income). It does not apply to other sources of additional taxable income.

------

Endnotes:

[1] The additional tax of $25 per $100 of additional     taxable income assumes that additional taxable     income does not put you into the 28% tax bracket.

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Well, you're not way off the mark. I took Turbo Tax 2007 and did the following:

Entered W-2 income of $90,000 for a husband and the same for a wife. Entered married filing jointly and one child. Entered a special needs adoption of $11,650 for 2007.

With standard deduction and one dependent I got:

AGI: 180,000 Standard Deduction: 10,700. Exemption Amount: 10,200 Taxable Income: $159,100 Tentative Tax: 33,541 Credits 8,770 Total Tax: 24,771.

I then gave the husband a $100 raise to get the marginal tax rate: AGI: 180,100 Standard Deduction: 10,700. Exemption Amount: 10,200 Taxable Income: $159,200 Tentative Tax: 33,569 Credits 8,748 Total Tax: 24,821

So, for a $100 increase in income, their taxes went up by $50. $22 came from the phase out of the credit and $28 came from the nominal tax rate. That's a

50% marginal tax rate in my book.

You said you were in the 25% nominal rate, so you've probably got deductions that I didn't include, but I think this makes your point.

The tax code is full of these kinds of phase-outs that kick up the marginal tax rate while you are in the zone of the phase-outs. The best known is already-referenced-here taxation of social security benefits. Another is the

50% tax rate on SS benefits for workers drawing SS before full retirement age. Then at higher income levels, exemptions are phased-out. I'm sure there are a bunch more, but those come to mine.

-- Doug

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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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