Effective vs Actual Tax Rate2012-06-14 by Eva Rosenberg
Today TaxMama® hears from KD in the TaxQuips Forum who is justifiably confused. “I was looking over our tax return and was wondering why we are paying almost 50% effective tax rates on our income. I’m currently unemployed and my husband is an independent contractor. Our CPA included a chart with this year’s tax return. It showed our marginal tax rate at 10%. But our effective tax rate is really between 41-47%. Could this be right? Shouldn’t our effective tax rate be lower than the marginal rate?”
Please ask your CPA to explain your effective tax rate to you. Without actually seeing the numbers, I certainly can’t explain. But I can guess.
Normally, you would be correct. But, bear in mind, any tax rate shown on his chart is only the INCOME TAX rate.
It does not include the self-employment taxes, which, in 2011 are 13.3% of his business profits. His business profits are ALL taxed at that rate – even if they are not taxed for income tax purposes. So your itemized deductions may have reduced the overall taxable income, but the 13.3% will be on a higher level of income.
For instance, if his business profits were $30,000, his SE taxes would be around $4,000 (rounded). Now, if you had a mortgage, charitable contributions, etc. bringing your taxable income down to $16,000, your federal income tax would be $1,600.
However, your total taxes would be around $5,600. That would appear to be 35% of $16,000 – even though you’re in a 10% tax bracket.
Does this look anything like what happened on your tax return?
And remember, you can find answers to all kinds of questions about tax rates and other tax issues, free. Where? Where else? At www.TaxMama.com.
[Note: If you were subscribed to the e-mailed version of TaxQuips, you’d be getting other exciting news and tips by e-mail, that never appear on the site. Please click on the join TaxMama.com link – it’s free!]
Please post all Comments and Replies in the new TaxQuips Forum .
Download the MP3 (0:00min, 4MB) or listen now...