Calculation of Marginal Tax Rate – Guidelines

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Marginal Tax Rate or MTR refers to the percentage that will be taken away from your next dollar of incremental taxable income as tax; i.e. let’s say your next dollar of income is 100%, then, the percentage of it that will be yours after taxation is equal to that 100% minus the marginal tax rate. It is essential to get a clear idea of what would be your marginal tax rate in order to go ahead with any kind of financial planning that you might have in mind. Supposing you have had a raise at work or have been offered a bonus, you need to know the marginal tax rate to estimate just how much of that money will be left with you after taxes; or if you want to contribute more towards your tax-deferred retirement plan and would like to calculate the after-tax cost towards the same, you need to figure out the marginal tax rate again.

MTR for Individual Assessee

If you are an individual tax payer who enjoys a healthy income, unfortunately, the federal component is going to be higher than expected due to various phase-out rules that apply to make up for or eliminate certain tax breaks. Some of these phase-outs affect individuals with lower incomes while some others impact those that fall within the middle and upper income brackets. To complicate this even further, there are more phase-out rules that will be applicable if you are an individual setting aside money for future educational requirements, contributing to individual retirement accounts or if you are a retiree. To illustrate this further, if your Adjusted Gross Income (AGI) crosses a maximum limit of $166,800, then, your itemized deductions for the year 2009 will begin to be partially reduced i.e. phased out. So, if you happen to be affected by this rule, you might be of the opinion that you fall into the 28%, 33% or 35% bracket, but in effect, your actual marginal tax rate will be higher as your itemized deductions start to reduce as you move up the income scale.

Calculation of MTR

Marginal Tax Rate can be calculated as follows

MTR = Change in present value of tax liability / Change in present value of income or expenditure

One must also note that non-taxable income or excluded income does not contribute to an MTR, leading to a zero marginal tax rate. Sources of income that are excluded partially such as situations involving employees receiving benefits from their employers result in a positive and most probably low marginal tax rate.

The formula given above or the examples cited are solely to give the reader an idea of the fundamentals of calculating marginal tax rate. Due to the complexities that arise out of the various phase-out rules that affect individual tax payers, it is best that you use tax return software or MTR calculation tools that are available online to estimate your marginal tax rate.