Hello to everyone reading this email. I have a question about investors, taxes and Marginal Tax Rates. If an investor salary qualifies him to be classified in the 25% Marginal Tax Rate, he will have to pay taxes on income gained on investments at his Marginal Tax Rate [25%]. Let’s suppose that he makes a profit of $29,000 on the investment. My question is shouldn’t the investor pay taxes on profit not at his marginal tax rate of 25%, but at the marginal tax rate of 15% because the $29,000 made from the investment endeavor does not exceed the minimum tax bracket requirement of $30,650 to place him in the 25% tax bracket? Thanks for the feedback
By definition you state that the investor’s salary has already placed him in the 25% marginal tax bracket. This means that each additional dollar earned will be taxed at the marginal rate until the next bracket is achieved. It sounds as though you are trying to seperate the two sources of income, salary vs investment income. If both incomes streams are earned by the same taxpayer then you add them together to determine your tax bracket. Of course if the investment income is earned inside a corporation (etc) and taxed as a seperate entity then the two income streams are seperate. Tax pro’s on this site will comment further.
Thanks for the repsonse 71tr. In the example I provided, I was trying to seperate the two sources of income, salary versus investment. Also, the investor is a partner in a L.L.C. taxed as a partnership, so the income gained will be reported on the investor’s personal tax return. Both the investment income and the salary income is earned by the same taxpayer, so I guess I will have the add the total income earned to accurately predict the tax bracket the I.R.S. will place the investor into.
Why do you need to predict another investor’s tax bracket?
Actually, Dave T, I want to understand how much taxes based on my marginal tax rate. I will have to pay upon making profits in a L.LC. I am trying to understand. If I fall into the 25% marginal tax bracket based on salary, I think I understand that if I make profits that around $32,000, this amount exceeds the minimum tax bracket requirement of $30,650, so I will have to pay taxes on the profit at the 25% marginal tax rate bracket. However If I fall into the 25% marginal tax bracket because of my salary, and I make a profit of $29,000, how can the profit be taxed at the marginal rate of 25% if the amount does not exceed the minimum tax bracket requirement of $30,650, shouldn’t I be taxed at a different marginal tax rate (15% marginal tax bracket)? I think that I am confused. If someone can provide an example using numbers, it will help alot. Thanks
To answer your question, let’s first discuss how your federal income tax liability is calculated. From the numbers you are using, I assume that you are a single tax filer, so I will use numbers and examples that only apply to a single tax filer.
The federal income tax is a progressive tax. This means that the first dollar of your annual income is taxed at a lower rate than the last dollar. For example, let’s say you have taxable income of $35K during the year. The first $7550 is taxed at 10%, the next $23100 is taxed at 15%, and the last $4350 of your $35K taxable income is taxed at 25%.
Because the next dollar you earn is taxed at 25%, we say you are in the 25% tax bracket. This does not mean that all of your income is taxed at 25%, just the next dollar you earn up to an annual total taxable income of $74200 where the 28% tax bracket kicks in.
Your taxable income is the aggregate of income from many sources. Salary income, non-qualified dividends, interest income, self-employment income, net rental income, and short term capital gain are all sources of income taxed at your ordinary income tax bracket rate and are all included in your total taxable income.
If you add your LLC income to your other taxable income, this additional ordinary income is taxed at the 25% tax bracket rate because your other taxable income was already high enough to make the next dollar you earn fall into the 25% tax bracket.
Your mistake is treating sources of income separately and computing taxes on that income independently of any other income you earn. I hope you now understand the nature of our progressive tax system and see that your total taxable income determines the tax bracket rate for the next dollar you earn.
Dave T, I appreciate your feedback. I am still uncertain about the subject area, I need to further my understanding about the tax arena. Thank you