 Income tax 2022-2023. Marginal and average tax rates. Examples. Let's do some wealth preservation with income tax preparation. Here we are in our example form 1040. We're using LASERT tax software. Although you don't need tax software to follow along if you have access to it running scenarios as we will be doing here is great practice. In future presentations we're going to go through the components of the 1040 in more detail. Right now we're looking at and focusing on the calculation of the tax. Seeing how the software is helpful to do that calculation but then also wanting to understand the concept of marginal tax and average tax. Most tax software doing that calculation for us and how we might use those numbers to communicate with a client. So right now we have our scenario being the filing status is single. We have Neo Anderson, Mr. Anderson. We have them living in California but we're really just focusing in on the federal tax preparation at this time. We're just going to start with a flat 100,000 W2 income so we can have our calculation. Support accounting instruction by clicking the link below giving you a free month membership to all of the content on our website broken out by category further broken out by course. Each course then organized in a logical reasonable fashion making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files and more like QuickBooks backup files when applicable so once again click the link below for a free month membership to our website and all the content on it. We're just using the standard deduction down below that gives us then this 87,050 so the bottom of the form 1040 is basically kind of a modified income statement getting us down to the equivalent of net income for tax basis basically that taxable income. This is the number now that we're going to apply the tax to. If it was a simple flat tax then we would just be multiplying this times one rate that would be the flat rate in order to get the actual tax. Notice that even if it was a flat tax it's still a complicated system because all the deductions and whatnot get somewhat complicated and we're not yet done after we calculate the tax here because we might also have credits that are applied to it down below and then we can think about the payments so even if it was a flat tax it wouldn't be the simplest of systems but we know we don't have a flat tax we have a progressive tax because the progressive tax is quite complex and we could see the progressive tax kind of reflected in tables like this that we looked at in prior presentations meaning as our income goes up we're going to have multiple tax rates that are going to be applied to that calculation we often depend on the software to do the calculation so oftentimes if I was to double check this number in practice I'm going to be able to double check and I usually do double check using excel to get down and recalculate this taxable income so I can make sure I've got my data input correct we'll talk more about that in the future but we're going to be more reliant oftentimes on the software to do the actual calculation because of the progressive tax system and because it'll get even more complex than just these different tables when we get into different things that might be taxed as ordinary income versus capital income dividend income could be taxed at different rates and so on and so forth so it gets quite complex the problem of course then is we want to be able to one think and see if this number looks correct since it's not just easy to recalculate it and two we want to be able to communicate that information to a client they're going to say well how did you get to that number well we're going to have to say something well yeah there's a progressive tax system that is being applied to get to that number but they don't usually want to hear a whole long detail about that what we want to do is kind of break it down to a simple number which is usually an average but we also want to look at the marginal rate because that'll have certain implications for budgeting into the future so that's usually what we're going to communicate to a client most of the times those things of course are calculated by the software but not actually on the form 1040 so this software for example has a summary calculation over here and so it's got the same kind of income statement type of calculation but then down at the bottom it gives us the marginal tax rate which is the highest tax rate and the effective tax rate which is going to be the average tax rate so that's what we're focused in on here so once again if we were to do this in practice we're going to probably and we'll double check the calculation to get down to the taxable income in a formula kind of component here i will do that in excel to get to the taxable income and then we're going to actually apply the tax or calculate the tax which is usually going to be done by the software taxable income to the tax and then we're going to communicate with a client and we're going to be saying okay what's what's then the average tax well i could say well there's a progressive tax system but you got taxed basically on average we can think of it as the 14774 divided by the taxable income not the gross income i'm taking the taxable income here so the bottom of like an income statement after the deductions 87050 and that's going to give us about 17 if i move the decimal over about the 17 percent that's how they're coming up with that 17 percent that also gets more complicated and stuff if you've got self employment tax and that kind of stuff that is applied if you've got a schedule c we'll talk a little bit more about that in the future but you could say you know that's about average what you're being taxed on not on the gross income not on what's on your w2 but rather what's what's on your net income after the deductions but that's not the number that you usually want to use to plan in the future if you think you're going to earn more or less money in the future you're not going to be taxed on your next dollar at 17 percent you're going to be taxed at your highest tax bracket which is the 22 percent here so if you're going to if you're going to earn more or less money and you're trying to try to figure out how much tax you're going to pay you can't use the average that's just that's not a really useful number although it kind of encapsulates possibly in some way the tax that was actually paid the useful number for action in the future is the marginal tax because if you earn more money in the future you're going to be taxed at the highest tax bracket here so if i look at if i look at my tables for example note that we had a single single filer tax brackets for 2022 and we're going to say that that the tax was or the taxable income was not the 100 000 it's the 87 50 so we're looking at the 87 50 so we would be in between here right and that would be the highest tax would be at the 22 percent so that's where they're getting that 22 percent we can kind of see it in a table type of format okay so now let's play with it a little bit and let's say okay well what if their income goes up so it's so it's into the 24 percent tax bracket or something like that if I go over here and say what's gonna happen if I bring this up to say 120 000 and back on over that means now I've got my wages at 120 and then I've got my deduction the standard which we'll get into later for that calculation 129 50 but the idea here is now I've changed my taxable income to the 107 50 so at the 107 50 we're at the effective or average tax rate of the 18.2 percent and the marginal tax rate is now 24 because that 107 50 if I look at my table I say 107 50 is in between here so we're at the 24 percent and you can then think about how much more income they would have to earn before they get up to that next dollar hitting the 32 percent remembering to remind the client that that does not mean that all of your income is now then going to be taxed at 32 percent I'm giving you one number even though you're being taxed with three different tax rates at this point in time because I'm trying to encapsulate in a single number what's going to happen so that possibly you can use that number to conceptualize what you've been taxed and the marginal tax rate to be used to actually do tax planning you know into the future now when we look at these tax brackets notice that we have different different brackets for a single filer versus a married filing separate tax brackets and then head of household tax brackets and then married filing jointly so that obviously is going to add more complexity to the situation so if I had a single filer making let's bring it back to the 100,000 100,000 this is where we started with but the tax brackets on your on your marginal and average will be different if I now say that we only we have the 100,000 for a married couple so I'm now going to say we have married filing jointly here and so now we've got two individuals and if I go to my tax tax summary we've got the same 100,000 so I didn't change the income but now we have two people involved and you can see there's a drastic change in the tax and therefore the marginal and effective tax rate so if I go back on over I could say okay what happened we have the 100,000 the standard deduction as we'll talk about later has increased because deductions are good and now you've got two people so you would think the deduction would kind of have to double and this is all somewhat complex because note in the past it used to be thought of that you would have like a one income household oftentimes and so so that if you were if you were thinking when that the tax code started you had situations where you had like a like a one income household one person worked for the same company for their entire life and their wages were fairly predictable from period to period because they worked at that same company the whole time obviously those things have changed quite a bit most people have to have two people working oftentimes and most people don't spend their all their time at one job and they possibly have income from multiple sources and and have multiple people working so that makes the calculations a lot different what we would expect you wouldn't want the tax system to do is disincentivize marriage that that would seem like not a good socially constructive thing to do so you would think then if you have two people you'd have to increase or double the deductions right which is basically what happens so that same 100,000 if it was for a married couple now results in the taxable income going to the 74,100 and so now when I look at my tables here I have to look at the proper table married filing jointly and now I'm looking at the taxable income of not 100,000 but that 70 something which I think is in between here which and also the brackets are different so notice yet 10 to 12 the 12 is at the 20 to 83 versus up here we had the 10 to the 41 at the 12 so we have totally different tables right which you can understand why you would need to do that but again it gets quite complex quite quickly but the bottom line for our calculation here is that the effective tax is 11 and that's going to be and that's like the average and then the marginal is the 12 so that's the highest rate now if you have your two people that were married and we go to their wages and their wages double I won't put a spouse's income yet but let's just say you know because they're one entity but now it goes up to 200,000 so now you've got the 200,000 minus the 25,900 and so that gives us the 174,100 the tax at the 29,536 here and our focus down here being that the marginal rate is now at 22 the effective tax at 17 if I look at that 174,100 on our tables we're going to say okay 174 is in between here so the highest bracket is the 22 the 22 so that's the general idea so when you're doing the tax preparation most likely we're looking at the 1040 and we're going okay I'm going to make sure my data input is all correct I'm going to verify it also with an Excel worksheet which I generally do I would do in practice as well to double check the taxable income is correct and then page two we've got the actual tax calculation which I'm dependent to some degree on the tax software because it's going to get more and more complex you can you can see the calculations in the software get more detailed oftentimes with the schedules here and then when I communicate with a client or when I talk about projections into the future we're not going to get too into the weeds about about the fact that you were taxed at multiple tax rates but instead we're going to try to summarize it in some way that is comprehensible into one tax rate which is often given in the tax software in some kind of summary where we're going to say yes your average tax rate was 17 percent remember the 17 percent however isn't applied to your gross income it's applied to your basically your net income or your taxable income after the deductions and you also have more complexity involved if you had credits that are going to be applied to it as well because that happens after you know the tax calculation and if you had something else that was applied such as the self-employment tax for Schedule C business that also kind of muddies up the calculation but that's the general idea when you make decisions in the future you want to use your marginal tax rate if your income goes up significantly then you might go into a higher tax bracket which doesn't mean that all your taxes will be taxed at the higher tax bracket but the dollars you earn after that threshold will be taxed at the higher tax bracket and if you're going to earn a lot more if your earnings are a lot different next year to this year we should probably do some projections so that we can try to figure out what your tax should be and what your estimates should be and so on and so forth in the future so that's the general idea