Income Tax 2021 2022 marginal and average tax rates software example, get ready to get refunds to the max diving in to income tax 2021 2022. Here we are in our Lacerte tax software, you don’t need a third tax software to follow along.
But some type of tax software is helpful for trial and error doing data input and looking at the impact on the tax return. In this case, the form 1040.
We have our mock taxpayer here, which we’re going to start out as being a single taxpayer, Adam Smith, live in Beverly Hills 90210, we’re going to be focusing in on the marginal tax rate and the average tax rate.
But as we do so we also want to think about how those rates are going to be calculated and look at the progressive tax system we’ve been discussing in prior presentations. So some of this information we’re going to be getting from the instructions on the form 1040,
which you can go to the irs.gov, IRS dot govt website to find and then we also have our tax brackets. Now these these components in terms of how the tax is actually calculated another area of confusion, if you ask a lot of tax preparers, they’re going to be dependent on the tax return,
they have the concept of the tax brackets oftentimes, but starting to think about the relationship between the tax brackets and the tax tables. And then the tax worksheets can be a little bit confusing.
So remember, in prior presentations, we saw that we have a progressive tax system, meaning we’re going to be taxed at different tiers.
Typically, as we apply the tax calculation, it could be even more complex than that, because we could have different things tax outside of this progressive tax system, such as possibly dividends, sometimes being taxed at a different rate. And capital gains, for example.
Now when you actually do the calculation from the tax software, it’s going to be pulling oftentimes from the tables up to a certain level.
So in other words, the tax tables are kind of constructed based on these on on this on these brackets here. So these brackets are used to construct in essence a table, which you can find on the instructions on the form 1040.
So if you were to actually fill out the tax return by hand, and you get to the line item of okay, now calculate the tax, then you’re usually going to be using the tables, which if you go to the instructions will look something like this.
So this is meant to basically be easier to find, although it’s less easy conceptually to understand what is happening with regards to the rates this way. Meaning, you’re just going to basically look and see are we a filer as single, married filing jointly married filing separately, or head of household? And then we see where our income range? Is it is it is it in between these thresholds.
And then we find the relative amount related to it, that’s going to be the tax calculation that we will be applying out based on the tables. Again, these tables should approximate the brackets of the progressive tax system, but kind of be easier to find, if you were to basically do this by hand.
So when you’re thinking about what’s actually being applied, what method are you using to calculate the tax, usually, you’re going to be saying I’m using the tables method.
Well, how are the tables derived, the tables are in essence derived from the progressive tax system, which has the increasing tears of taxes that we have looked at over here with regards to the taxes going up, you know, in a bracket type of format.
So that’s going to be that’s going to be this information. And then if your income is above a certain threshold, if it’s above a certain threshold, then you’re going to be using the tables. So then if it’s above here,
then you’re going to be using these tables on down below. So if it’s over 100,000, or over use the tax computation worksheet. So in other words, you’re going to be then using the worksheet down here, which you would think might look like the progressive tax tiered system that we looked at before.
But again, it’s a little bit different of a calculation because they’re trying to make it as come as easy as possible to calculate, in essence, not as easy as possible to understand conceptually, the tax system. So keep that in mind. When you’re thinking about the taxes.
You’re saying, Okay, I’m thinking about the taxes, I’m thinking about it generally in terms of tables, we also have to think about the different tables that are going to be applied based on the different filing statuses such as married, single head of household and so on. And and then that’s how I want to explain it to people.
When I’m actually thinking about how the tax software is calculating the taxes. They’re generally calculating the taxes by forming that progressive system into a tax table, which should be easier to draw the number from by just finding the range and drawing the number From it,
however, it’s less easy to see come conceptually. And if you’re over a certain threshold, then that’s when it’s going to be basically using the calculation down below.
Now again, you can see that the different tables are going to be lined up for the filing statuses. So what’s what do you need to be dependent on the calculation of the tax? Well, you’ve got the single taxpayer who is going to have different progressive rates.
So you’re going to need a whole different set of tables, then the married taxpayer, because you can imagine, obviously, that if you’re married, you’ve got two people filing one tax return.
So that’s going to be a whole different set of progressive income tax tables that are going to be applied there. So you got to say, okay, Are they single, are we married, a head of household, and so on and so forth to look at the proper table,
when you’re looking up the brackets, you need the same kind of thing, if you’re thinking about it conceptually, then you have to have Okay, these are the single brackets here and the use of the income tax thresholds.
And then if you move to married filing jointly, you have different brackets right, now you have to 19 Nine at the 10% bracket at the upper level versus the 19 950. That would of course, make sense. Because to be fair, if someone was single and then married, and they both worked, then you would expect then you got to kind of compensate that with the tables.
So you got to know what the filing status is, then in order to apply the tables, the tables then being converted to apply the brackets, the brackets then been converted into the tables that are usually going to be used,
calculating the taxes, unless the taxes are over a certain threshold, in which case the software is actually going to be using the worksheet. So let’s let’s think about a couple of these just to get an idea of it. So let’s say okay, let’s say that are single filers. So we’re gonna sync single filer,
Adam Smith, made 100,000 w two income, they had just the standard deduction of 12,550, that gives us them the taxable income of the 87 450. So 87 450, that’s usually what we confirm. On our side, if I was to, if I was to kind of confirm my data input,
I would look at it in a formula basis and say, okay, wages 100,000, that makes sense. And then standard deduction was this amounts that gives me I can recalculate quite easily and say, okay, yeah, that’s going to be taxable income at seven 450.
What tax payers don’t usually confirm on their own oftentimes a recalculate is the average tax rate of, in this case, 17.2, what they what they usually do is say, okay, tax software, you helped me out from there, apply the tables, calculate the tax, and then we can basically, then we can calculate and see what the average tax rate is by dividing this out and picking up the 17 to so in other words,
I would then double check this number most likely, and then depend on the software to give me the actual tax calculation. So if I jump back on over and Sarah, what’s the tax calculation? I’m going to go to page two then. And it says 15 150 15 150. So if that’s the case, we can determine then I would put that into my worksheets.
Okay. There’s, there’s the 15 115. And that would allow us to calculate the average tax here to the software will also do that. If I go on to the software, and I go to my tax summary, I can go back on over and say, okay, and most software has this,
this isn’t a cert tax officer, but no, most tax shelters have this, which is basically breaking this down into more of an income formula basis. And we’ll talk about the formula more in a future presentation. But down below, you can see the calculation of the marginal tax and the effective tax.
So now it’s calculated the tax the tax being here, the total tax that has an underpayment penalty, we’re not going to take into consideration right now. But it has the marginal tax at the 24%. Now, does that make sense? If we think about that, we can’t really say Okay, does that make sense from my tables here? Because it doesn’t tell me what the percents are.
We’ve got to jump back to the brackets and say, Okay, does that make sense if they made 100,000, that would put them in between this bracket from 86 376 to 164. And that’s at the 24%.
So that’s their highest bracket, that’s their marginal bracket, the bracket at the margin at the end? What’s their average or effective tax 17.2. Now the 17.2 is calculated like we said, the tax is up here.
The total tax is the 1501 five divided by the taxable income. So taxable income 87 450. Now again, remember the taxable income if I if I there’s the 17.2, if I multiply it, times 100. There we have it.
Now remember, the taxable income still a little bit troublesome, a little bit confusing, because it’s after the deductions and the deductions are not always things that we used in order to generate the revenue like you would think would be for Earned income tax.
So you can deduct things that are personal, like mortgage interest and whatnot, which can be significant deductions. So that’s still kind of skews it a little bit. Also, the credits skew it a little bit. So for example, if I went back on over here and said,
Well, what if I add? What if I add like a dependent and say there’s a child tax credit that’s going to be involved here, let’s put the dependent on the books and say, we’re going to claim a dependent.
And we’re going to put that on the books go back to the forums. If I go back to the first page, we’ll talk more about doing this later. But just in the calculation of the average and marginal tax, what’s that going to do?
Because now I’ve got the same calculation for the taxes on page two here, the 15,015. But then I’ve got this, this big credit down here, which is $1, for dollar money back type of situation. So if I go to my tax summary, how’s that going to be calculated, because it’s still the the effective, the marginal tax is still at 24.
So it didn’t change my top tax bracket. And then the effective tax is still at the 72. But again, that doesn’t, that’s not quite, that’s a little deceiving. Because the 72 is still being calculated at this tax calculation of a 1501. Five divided by the taxable income. And the tax, the taxable income was the 87 here, divided by the 87 450.
So there’s the 17 to, but really, after this credit, and I’m not going to take into consideration this underpayment penalty I had, I really had the 12 892 total,
I’ll add back the underpayment penalty to to seven, so it’s really 13, one, nine, and if I was to take that divided by the taxable income at seven 450, it’s really something like 15%, because the credit, it was put down here, and I didn’t pay taxes because of the credit.
So that also confuses the average tax rates. So that average tax rate is really kind of confusing. But remember, the average tax rate is something that you want to talk to somebody about in terms of this is kind of what you’re actually paying on average.
But the marginal tax rate is often what you’re concerned about for decision making, because decisions are made on the margin. So if they made another dollar, they’re going to be paying taxes at the 24%.
So if they’re saying I’m going to make more money next year, then you’re going to say Yeah, well, that next dollar is going to be taxed at 24%. But what about the average of 17?
Yeah, the average is 17. It’s what you average pay, but your highest bracket is what you’re paying out now. That’s at 24%. Now that average tax gets even a little a little more confusing, if you were to say, well, what would happen?
For example, if I say the income down here was down to like, let’s say the income was like 20,000 20,000 on the income and bring it on back to the forms. So now my taxable income, so now I’ve got my income at the 20,000, the standard deduction is 12, five, my taxable income is 7005 40.
And so my total tax, my tax is going to be 748. But I’ve got a I’ve got this big credit here, which is the the tax credit of the 3600. So that means I’m going to have an overpayment or basically what they’re saying is a refund here of the 2008 52.
So I’m actually getting money, right? I’m getting more money than I’m getting a refundable credit. So the taxes here are acting as like a benefit for me. And you can see down here that the effective tax is still at 10%.
Why is it at 10%? Because it’s basically calculating this, this, this tax, the total tax of the 748 divided by the taxable income of the 7450. So there’s the 10%, but we’re not paying 10%
Not only we’re not paying 10%, there’s a negative, there’s a negative tax, right, because we’re getting more money back below below zero. So really, what’s happening here is we’re getting 2000 So we’re getting 2852 divided by the taxable income 7450.
So we’re receiving, you know, 38% 38% on so that. So that’s another area where this this effective tax is kind of confusing because again, the credits, throw it off, obviously that that effective tax or the average tax isn’t really applicable in that case. So those things can kind of throw it off a bit. So let’s go back on over and say, Okay, let’s go back and bring it back to our original example.
So we’re going to go to the deductions and or the dependents and no dependent and bring the wage back up to the 100,000 100,000. So we’ll bring that up. If I go back on over, then we’ve got our we’re back up to that 15. We’ve got the marginal at the 24.
And in the 17, so we check the 24 on the marginal. If you were to calculate this this tax, then you could say, well, could I calculate it? Based on based on this calculation, we could try, we could say,
Okay, let’s put it on the side here. And I’ll put my brackets on this area, and we’ll try to calculate it using the brackets and then we’ll look it up in the table. So if we’re in if we’re down here, and we’re saying, Okay, we’re, we’re within this range that 24, we’d have to say that it’s going to be the 14 751.
So 14 751 14751, and then we’re going to say that we had the, the one, the 100,000 minus the actual, it’s gonna be the taxable income, taxable income, which is the 87 450.
So we’ll take the 874 50 A minus and then we’ll pick up the lower level here, we’re in this range where the lower level is going to be minus the 86376 is going to be 1074, at the 24%.
So I’m going to say, Okay, now we got the 1074 times point two, four, making that at four cent, multiply that out this times this. And we’ll add that up to 14 fourths 751, plus the 258, comes out to 1509, which is closed, and not exactly what the tax was calculated here.
And the tax calculated here, because the system actually used the tables. So the tables, if we go into the tables is trying to try to put these into ranges. So let’s find it in that way.
So we’re going to be in the single column, I got to find the area that’s got the, the amount of 87 450. So we’re looking at seven 450. So I’m scrolling down scrolling down at seven 450. Scrolling down, and way down here, we see here, we got 87 450. And usually, it’s going to default to the higher one. So this one’s on the mark.
So it’s on both sides. So it goes to the higher at 87 450. Here 280 751 In the single column. And there’s the 1515 that has been used to calculate the actual the actual tax up top. So that’s basically how the tables are working. Now, if I was to change it and say, Well, what if they were married,
let’s add, let’s add a spouse here. So now we’ve got Adam and Eve Smith, both living in Beverly Hills, 90210. They’re still earning the 100,000. And so they got the 100,000. But now the standard deduction is at the 25.
One, because they’re married. We’ll talk more about that later. But now that that would mean that the taxable income is at the 74 900. So now the taxable income has changed, because it nothing else has changed. They’re just married now.
So that standard deduction if that’s what they’re taking, is basically doubled, because there’s two people now making their their income different now at the taxable income 74 800. So if I go to the tax summary then and say, Okay, well, what’s happening down here? Now they’re at the marginal tax rate, the highest tax rate is 12%. Does that make sense?
Well, let’s go to my table here, I can’t use the single table, I got to go to the married table, and their income is between is at is at the I’m looking for taxes, 74 Nine, so the 74 Nine should be right, right in between here, which is at the 12%. So it’s in between, they’re at the 12%. So it’s like okay, I could calculate that by saying 199019901990
And then add that to the difference. And by the way, I can change the standard deduction in my worksheet and simulate that. So I’m going to say married, married filing joint married filing joint is going to be that one so there’s there it is the 74 900 If I go back to my tax software, 74 900 then I rely on the software to calculate it. 8593
So 8593 So I’m going to say okay, there’s a that’s not that’s not where it goes. It goes down here. 8593.
So there’s my my average that has been calculated. I can try to recalculate it with the brackets. And I’m going to say okay, there’s the, the 990 and then I’ll pull out the trusty calculator and I’m going to take this The difference of the 7490 minus back on over here, minus the lower area, which is going to be the 19901.
So I have a difference of 54 999 at the 12%. So there’s the service is going to be 54 999 at 12%. And so there’s the 8590. Not exactly this, because this was calculated from the tables. So if I go into the tables, then I’m going to go into the tables. And I’m looking for that calculate that number of the net income 74, nine this time.
So 74, nine. So here it is. And so and now I’m not in the single column, right? I’m not in single anymore. I’m in married filing joint. So I’ve got to go into married filing joint.
And this is what the software will do for you 74, nine here, and I’m going to go here, and that’s going to be the 8593. Right? Is that what it was 85938593 there, and 8593 here.
So that’s how it’s the they’re actually calculating it in the software. And then we can see what are the impact on the marginal tax rate. So you can see how this gets quite complex even even though you can calculate it pretty easily.
But when you try to explain it to people, you say, well, that comes from the table. But what does that mean? What’s my actual tax? Well, then I have to go to the brackets to tell you what your average taxes but what’s what am I going to do if I make more money?
How’s it going to affect me next time? Well, then you go to the effective tax rate or the marginal tax rate, then you go to the marginal tax rate