YOUR MARGINAL TAX RATE MAY BE HIGHER THAN YOU THINK

Fall, 2009

Your marginal tax rate is based on your taxable income and can range from 10% to 35%.  However, because of phase outs, you can lose part or all of your deductions, credits, or exemptions.  The extra tax due means that you are paying more than your marginal tax rate.       

Let’s start with itemized deductions. 

• Medical expenses are only deductible to the extent that they exceed 7 1/2% of adjusted gross income.  This exclusion alone can add anywhere from .75% to 2.625% to your marginal tax rate.
• Investment interest expense deduction is limited to investment income.
• Contributions can also be limited on deductibility.  If your contributions exceed 50% of adjusted gross income, the excess cannot be deducted but must be carried forward to future years.  There is also a special 30% limitation on certain capital gain property contributed.
• Miscellaneous itemized deductions are only deductible to the extent they exceed 2% of adjusted gross income.  This exclusion can add .2% to .7% to your marginal tax rate.
• Casualty and theft losses over and above insurance proceeds must exceed 10% of adjusted gross income.  This can add 1% to 3.5% to your marginal tax rate.
• Gambling losses that exceed gambling winnings are not deductible.

Now, if all of the above is not enough, your itemized deductions can be further limited if your adjusted gross income exceeds $166,800 for all filing status except married filing separately which is $83,400. Three percent of adjusted gross income over this amount reduces your itemized deductions.  This can add an additional .3% up to 1.05% to your marginal tax rate.

Personal exemptions are also subject to phase outs.  If your adjusted gross income exceeds a certain amount, your exemptions are reduced $50 for each $2,500 or fraction thereof over these thresholds.  These thresholds are $166,800 for single taxpayers, $208,500 for head of household, and $250,200 for joint returns.  If your income is high enough, your deduction for personal exemptions will be eliminated.. 

You are allowed a $1,000 child tax credit for each dependent under the age of 17 years old.  However, if your income exceeds $110,000 if married or $75,000 if single you lose $50 for each $1,000 over the above limits.

Child care credits are also limited from 20% to 35% of the child care expense up to $3,000 for one qualifying child or $6,000 for two or more children. 

Student loan interest is deductible up to $2,500.  However, this is phased out for single taxpayers with $60,000 to $75,000 of adjusted gross income and $120,000 to $150,000 for married persons.

Higher education expenses are deductible up to $4,000 if your adjusted gross income is less than $65,000 for singles or $130,000 for married, or up to $2,000 if your income exceeds these levels, but are lower than $80,000 or $160,000 respectively. In addition, there are two education related credits, the Hope and the Lifetime Learning credits that phase out for joint filers between $100,000-$200,000 and singles between $50,000-$60,000.

There are many other limitations that can drive your marginal tax rate up.  Just keep in mind when you look at your marginal tax rate from the tax rate schedules, you are being mislead because they can be much higher. 

Proper planning may help ease the tax burden of these limitations.  Call G.R. Starbuck & Co., P.A. to discuss your situation.