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URL:  http://boards.fool.com/a-further-question-please-if-the-earning-of-25321103.aspx

Subject:  Re: Penalty for reaching next tax bracket? Date:  3/23/2007  1:36 PM
Author:  Goofyhoofy Number:  93228 of 121589

A further question, please...
If the earning of $1 above bumps one into the 25% bracket for the next dollar, what is the tax effect if the $1 is from LT Capital Gain from a stock sale?
Or, to make it more specific and interesting, consider a $100,000 or more LTCG over the $61,300 magic number.


Mostly, a LTCG stock sale will be taxed at 15%. If you are above the 15% marginal tax bracket (AGI) then it's 15% CG, period (for stocks; other things are different). However it's my understanding that there is a straddle in which enough gain could put you into a higher marginal bracket IF you are in the 5% or 10% AGI bracket. Emphasis on "marginal." Here's an explanation of that (which I don't think is relevant in your case, but here it is anyway. It's explained at the bottom of page 1, and your case is talked about at the top of page 2)
http://www.bankrate.com/brm/itax/tips/20010305a.asp?caret=1

Back to the OP: I know it's been explained, but this is simpler, I think. You can never be bumped into a "higher bracket" which causes you to lose money. The taxes increase only on the NEXT dollars you earn.

To make the numbers easy, suppose we have 3 people earning $10K, $20K, and $30K, and suppose the marginal tax brackets are at 0-$15K, $15K-25K, and $25K and up, and finally, suppose the taxes in those brackets are 10%, 15% and 20%.

Mr. A earns $10,000, he pays 10% of that $10,000, or $1,000

Mr. B earns $20,000. He pays 10% of the first $10,000 or $1,000. Then he pays 10% of the next $5,000, or $500. Since the marginal bracket jumps at $15,000, he pays his last $5,000 at the new percentage: 15%, or $750, for a total of $1,000+500+750 = $2250. (His actual rate is $2250/$20000, or 11.2% - even though he is now in the "15% bracket.")

Mr. C earns $30,000. He pays 10% of the first $10,000 or $1,000. Then he pays 10% of the next $5,000, (getting him to the $15K bracket cutoff) or $500. Then he pays 15% on the next $10,000 (getting him to the $25K bracket cutoff), or $1,500. Then he pays 20% on the income between $25K and $30K, or 20% of $5,000, or $1000. In total he pays $1000+$1500+$1000, or $3500. (His actual rate is $3500/$30,000, or 11.6% - even though he is now in the "25% bracket".)

Notice that all three pay the identical tax on the first $10,000. Earning more does not make them pay more on that $10,000, they only pay more on the NEXT marginal dollars. There is no way to "be penalized" and "go backwards" for earning more. The more you earn, the more you keep, although the marginal "keep" is less in higher brackets.

OK, maybe that wasn't easier. Heh. Heck, at least I hope my math was right.
 


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