We have been using TurboTax for years, and this year have a small additional entry on a Sched E for a commercial warehouse that is rented out.
Just taking our basic normal Income/Tax calcs, it appears we are in the 12% tax arena.
The income on Sched E line 26 is only $2,752. However, with the inclusion of it, our refund slides from $4,914 down to $4,029.... -$885 This appears to be taxed at 32% ( $885 / $2,752) Why 32% vs our implied rate of 12% Am I missing something in the data, calcs, or mindset ?
Remember that your next dollar of income is taxed at your marginal rate, not your average rate. That doesn't seem to entirely account for the difference, though. There are a lot of phaseouts and adjustments based on AGI, so adding that amount to your AGI may have reduced your allowable itemized deductions, or increased the amount of your Social Security that is taxable, or reduced an otherwise allowable credit, etc.
TurboTax makes is easy to go form hopping and work backwards to see what triggered this. As a marginal 32% seems high, I'd suggest it was you topping the 28% and going in the 33% bracket, but if your income is below that level, other things may be triggering.
I had a woman in the 15% bracket, but her IRA withdrawals were about to trigger the tax on social security so the next $1000 withdrawn would increase her tax bill well over 40%.
this may just be some kind of twisted math puzzle. I created 2 tests - one with the real estate numbers, and one without. In each case - line 44 Tax was 13.66% and 13.04% of the AGI.
It was just a head scratcher as to why a rental increase of $2,752 on Sched E line 26 - would have an increase of $885 - exactly what the refund is decreased by... $885 and yet none of the other numbers, deductions changed.
It's like 30% tax on the income - and yet the AGI vs Tax still calcs only 13%
a) The effective tax rate (total tax bill divided by total income) is meaningless. (I know, some here may actually like this number, I'm open to understand its real value)
b) There's your marginal tax rate, the 10,15,25,28, rates we love to discuss here, and at cocktail parties.
c) There's the net difference in your tax bill based on the +/- $100 of income from whatever source. This number (I call it the "phantom marginal rate" for lack of a better expression) is the effect of the phaseouts of certain credits, phase in of certain taxable items, etc. There are income limits for, say, the child care credit. I wrote an article for TurboTax
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titled Your New Little Tax Deduction. In it, I describe how There are a number of credits you can get which are phased out at certain income levels. This creates a chart (in my brain, anyway) in which the next $100 of income doesn't create incremental tax due at one's marginal rate. While the article was targeted at new parents, it talks about the impact of income on the potential credits available. I believe you need to really, really, ignore (a), stay aware of (b), but focus on (c).
I like to call that the "nominal bracket rate" or "advertised bracket rate."
I like to call that the "marginal rate" or "true marginal rate" since it is exactly that -- the actual, experienced tax rate on your next $100 of income.
You may be missing something, but I doubt its significant. Sometimes a little extra income is what is taxed at the next bracket's rates, making it look like THAT income is all being taxed at that rate. But it doesn't quite work like that.
Using your methodology - putting in all your other income and deductions first, then putting in your rental activity makes it FEEL like the rental is being taxed at 32%. But if you follow your methodology logically we could just as easily say that if you entered the rental activity first (and the profit was low enough) that IT wasn't being taxed at all. Rather it was your INTEREST income that got taxed at 32%.
You cannot point to a specific dollar and say THAT DOLLAR got taxed at a specific rate. ALL your income is aggregated then taxed. It would be more accurate to say the income reported on each separate line on the front of your 1040 was taxed in each tax bracket that applies to you.
Take your taxable income before and after the Schedule E and divide it by the tax liability before and after the Schedule E. I'm betting that your effective rate isn't 32%. That is the effect of blending. When the next dollar is taxed at a higher rate it raises the effective rate.
I like "true marginal rate" and I may go with that. I suspect that even amongst those familiar with taxes, any reference to this will still take a bit of dialog. For the former "advertised bracket rate," it sure opens itself to the claims of false advertising as the discussion goes to true marginal rate...
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