I’ve developed a tool that can be used for tax planning purposes. In order to make decisions like how much to work, how much to save in a 401(k), etc, you have to know what your effective marginal tax rate is. Unfortunately the tax code is so complex that knowing one’s effective marginal tax rate requires nothing short of a miracle.
Here’s an example of the marginal tax rates facing me as a parent of 5 young children:
The winding up and down of the earned income tax credit, child tax credit, phasing in and out of the AMT, etc., produce a wild path of effective marginal tax rates over the plotted income range. At low income levels, the effective marginal tax rate goes from -60% to 31%, which is an unbelievable swing. In particular, this is what’s happening for my particular scenario with 5 kids:
- At the onset, the earned income tax credit (EITC) ramps up at a rate of -45% effective marginal tax rate (EMTR).
- At 3k in income, the additional child tax credit (ACTC) provides an additional -15% EMTR for a combined -60% EMTR
- At 15k, the ETIC plateaus, leaving only the -15% EMTR caused by the ACTC.
- At 25k, the EITC ramps down at a rate of 21%, bringing EMTR to 6% (21% ETIC -15% ATCT).
- At 38k, the additional child tax credit max’s out, bringing effective MTR to 21% for ETIC.
- At 41k, taxable income is finally non zero due to income > standard deduction + personal exemptions, entering 10% statutory tax rate combined with 21% effective MTR for EITC for an EMTR of 31%.
- At 55k income, the EITC is officially dead bringing effective MTR to statutory rate of 10%.
- At 61k we enter 15% statutory rate.
- At 111k, we enter phase-out of child tax credit, adding 5% effective tax rate for a combined rate of 20% effective tax rate.
- At 117k, we enter the 25% statutory rate for a combined effective tax rate of 30% (25% statutory + 5% ACTC phase-out).
- At 181k, we enter AMT territory with effective tax rates of 38%.
- Etc, etc, etc.
It is unbelievable how complicated our tax code is in practice, with all the phase-in’s and phase-out’s of credits. If you’re into optimizing, like I am, it will pay to understand these nuances and make tax sheltering decisions in a strategic manner. I’m hoping this tool will empower normal people to make wise tax decisions in the face of a hopelessly complicated tax system. By viewing how tax rates change as a function of income, one can optimally choose the right amount to shelter in a 401k, etc.
The file is downloadable here: 2016 federal tax calculator – Beta
It’s still in Beta mode. For example, I’ve hard coded everything as married filing jointly but will fix this soon. Further, I haven’t yet coded the following: correct treatment of investment taxes, phasing out of trad-IRA deductibility, etc. But hopefully it’s a good start. It checks very nicely with turbotax’s taxcaster (link) for the basic scenarios I’ve run so far.
You’ll get the most out of this tool if you use it after reading Step 2 – Minimize your tax burden.
Directory of wealth accumulation steps: