Having a consistent number year over year for what you’ll owe on your taxes would certainly be convenient. Yet fluctuations with the tax code and the ever-changing circumstances within our own lives tend to put that dream out of reach. There are, however, ways to help make sure that the reality of your tax responsibility is closer to your own expectations by year’s end. That starts with a basic understanding of your marginal tax rate and your effective tax rate—and how the process differs from how a flat tax system would work.
How Would a Flat Tax Be Different?
Doing the math for our marginal tax rates can be a little tricky. But working with a tax planner or accountant can help you determine a reasonable prediction for what you could owe come tax time. If things were simple with the tax code, we might use a flat tax. This would function as a universal rate. So your tax obligation would essentially have the same percentage whether you earn $30,000 or $300,000.
For example, if we had a flat tax rate of 10%, someone with a $30,000 income would owe $3,000 in taxes. The $300,000 income would then have a tax obligation of $30,000. This seems pretty straight-forward, right? Well, our tax code has a different setup.
Let’s Define Your Marginal Tax Rate
Marginal tax rates are a feature of our progressive income tax rates system. This is the tax rate that gets applied once a dollar you earn bumps you into the next tax bracket.
In our IRS model, a taxpayer who earns $50,000 would ultimately have an effective tax rate of 13.2%. This is because their income ranges from the 10% tax bracket, into the 12%, and then the 22% tier. The 22% marginal tax kicks in for each dollar earned after the income surpasses $41,775.
The tax rate that you actually pay based on your earnings is referred to as your effective tax rate. Taking the average of those three different tax rates for a $50,000 income brings the effective tax rate to 13.2% for the total income. This is the tax amount that is calculated after taking your income and applying the tax, deductions and credits, exemptions, and additional adjustments on your return. This will be your set tax obligation, as determined by a percentage of your income.
If it sounds complicated, that’s because it is! That’s why we’re here to help. No one likes surprises when filing their return. Let us work with you to look ahead and plan accordingly. There are likely options that you can still explore to lower your tax liability if you stay informed!
Forecasting Additional Income
If you expect your income to fluctuate this coming tax year, it can be smart to schedule a consultation with one of our team members here at NSO & Company. That way, we’ll be able to help you forecast how that additional income—or any losses you might be anticipating—could move you into a new marginal tax rate.
We’re passionate about helping our clients navigate their tax planning process and stay organized throughout the year. We proudly partner with clients on individual tax planning, as well as tax planning for small businesses throughout the Central Indiana area and beyond. Please don’t hesitate to reach out so we can schedule a time to talk—we’re here to help!