What is a Marginal Tax Bracket?
Many times I will get a farmer to ask me what their marginal tax bracket is. But they also want to know what the average rate they paid on their total income. These are two different numbers.
The average tax rate is calculated by taking total taxes and dividing it into your total income reported on the return. Some use adjusted gross income and some use taxable income to arrive at this number.
However, the marginal tax rate is much more precise. How much does your income tax go up if you add $1 more of income. This rate starts at zero and goes up to 37% in most situations. However, there are many times where the marginal tax bracket can be higher. Let’s look at some of those situations.
If a farmer is collecting social security, the marginal tax bracket can be 85% higher than the normal rate in certain situations. This means a 12% tax bracket becomes 22.2% bracket. A 22% bracket could become 40.7% bracket. It would be tough for a bracket to be higher than this since social security taxable income likely maxes out before you hit a higher tax bracket.
Once the ACA premium tax credit rules revert back to “normal”, your marginal tax rate can become very large if you go over 400% of the poverty level for your family. As an example, assume you receive a $10,000 premium tax credit during the year and you go over the 400% poverty level by $1. This means your marginal tax rate is now 1,000,000%. This is what I call a high marginal tax rate.
For those farmers on Medicare, the income-related monthly adjusted amount (IRMAA) can create a large marginal tax rate. For example, if a married farm couple’s income go over each of the five levels where IRMAA kicks in, the marginal tax rate ranges from a low of 81,600% up to 245,040%. These are also high marginal tax rates.
The key on both of these marginal tax rates is there is no phase-in of the extra tax. Once you go over by one dollar the full amount of the tax kicks in. We call this the tax cliff.
As you can see, there are the normal marginal tax brackets and then there are the massive marginal tax brackets that farmers and other taxpayers need to make sure they plan to avoid if they can. This is always something you should discuss with your tax advisor each year.
Paul Neiffer is a certified public accountant and business advisor specializing in income taxation, accounting services, and succession planning for farmers and agribusiness processors. Paul is a principal with CliftonLarsonAllen in Walla Walla, Washington, as well as a regular speaker at national conferences and contributor at agweb.com. Raised on a farm in central Washington, he has been immersed in the ag industry his entire life, including the last 30 years professionally. Paul and his wife purchase an 180 acre ranch in 2016 and enjoy keeping it full of animals.
Comments are closed.