Is Being Effective Better Than Being Marginal?

Understanding the difference between these two tax rates

The tax code is filled with terms we rarely use in everyday conversation. Two of the more common are Marginal Tax Rates and Effective Tax Rates. Knowing what they mean can help you think differently about your potential tax obligation.


Marginal Tax Rate: This is the tax rate applied to the “next” dollar you earn. Since our income tax rates are progressive, the next dollar you earn could be taxed at as little as zero or as high as 39.6%!

Effective Tax Rate: This is the tax rate you actually pay. This is simply taxes you pay divided by your total taxable income. Said another way, after taking your income and then applying taxes, deductions, credits, exemptions, and other adjustments you are left with your true tax obligation. This obligation is a percent of your income.

A Simple Example

Consider two people; Joe Cool who earns $50,000 and Chuck Browne who earns $500,000. If we had a flat tax of 10%, Mr. Cool would pay $5,000 in tax and Mr. Browne would pay $50,000 in tax. Both of their Effective Tax Rates would be 10% AND their Marginal Tax Rates would also be 10% because each additional dollar they earn would be taxed at the same 10%. However it is a different picture when you apply our progressive tax rates:

If we use the 2013 U.S. tax table for a single filer, Joe Cool pays $6,608 and Chuck Browne pays $151,065 in federal tax. This is because tax rates applied to Joe Cool’s income are (10 – 25%) while Chuck’s income over $50,000 gets Marginal Tax Rates of (25 – 39.6%). Ignoring other tax factors, our two taxpayers’ tax rates are:

Joe Cool Chuck Browne Diff +/- Comment
Effective Tax Rate 13.2% 30.2% +17.0 Chuck pays 30.2% of his income in tax; Joe 13.2%
Marginal Tax Rate 15% 39.6% +24.6 The next dollar each earns will be taxed at this rate.

Why Care?

  • Calculating Returns. The true return you receive on any taxable investment will be determined by your Marginal Tax Rate. A $500 profit from a new investment could cost Joe Cool 15% in federal tax, but it could cost Chuck Browne 39.6% in federal tax.
  • Phase-outs can provide a dramatic impact on Effective Tax Rates. The simple examples above do not account for income limits applied to many tax benefits. Additional income could have a very dramatic impact on Joe Cool if it triggers losing things like an Earned Income Credit, or Child Tax Credit. This could increase your Effective Tax Rate while not touching your Marginal Tax Rate.
  • Extra work can help the taxman more than you. There have been cases where adding a second job can actually cost you money by not understanding the impact of the income on your Effective Tax Rate. This is especially true for retired workers receiving Social Security Retirement Benefits. That extra job may make your Social Security benefits taxable.
  • It’s not that simple. In addition to all the different income phase-outs for credits and deductions, your Effective Tax Rate could be impacted by the elimination of itemized deductions, reduction of exemptions, the Alternative Minimum Tax, and the marriage penalty.

It is a good idea is to understand your Effective Tax Rate and your Marginal Tax Rate. Look at last year’s tax return and calculate your Effective Tax Rate. Then look at your income and determine what your Marginal Tax Rate is if you earn additional income. If you anticipate an increase in earnings, consider forecasting the impact on your Effective Tax Rate.

Often Overlooked Medical Expense Deductions

Avoid taking the easy way out

To take your medical expense deduction in 2012 your allowable expenses must exceed 7.5% of your Adjusted Gross Income (AGI). In 2013 and beyond, unless you are 65 or older, this amount goes up to 10% of AGI. So why bother? You might be surprised at how much this expense might be. Here are some tips:

  1. Don’t take the easy way out. So many think itemizing deductions is such a pain, that they forego the work of collecting valid receipts. Don’t let this happen to you. Collect the receipts and determine if you may be giving away money to Uncle Sam by not itemizing your deductions.
  2. Insurance Premiums. Many insurance premium payments are deductible, including long-term care insurance. Many seniors omit their Medicare Part B premiums because they are automatically deducted from their Social Security benefit check.
  3. Look to your face. Eye care and Dental care are allowable deductions. This includes overlooked expenses for:
    • Eye care: exams, glasses, contact lenses, laser eye corrections, and insurance premiums
    • Dental care: exams, fillings, fluoride treatments, crowns, dentures, orthodontics, and related premiums
  4. Travel expenses. Parking fees, tolls, and mileage to and from appointments also count. So keep a travel log.
  5. Get a prescription. While over the counter purchases are not deductible, if the doctor prescribes the medicine or service it is. So get a prescription for your acid reflux versus buying over the counter meds. Get a prescription for a weight loss program and that could be deductible as well.
  6. Other missed opportunities. Some other commonly overlooked items include; smoking cessation programs, alcohol and drug treatment programs, home remodeling for handicap access, and visits to other health providers (acupuncture, chiropractor, and podiatrist to name a few).

Medical care is very expensive these days, and it won’t be getting any cheaper. It does not take much to make your expenses meaningful tax deductions, but only if you keep track of them.

Where’s My Refund? 2013 Edition

Where's my Refund“Where’s my Refund?” This popular feature on the IRS web site ( allows you to see the status of your refund after filing your income tax return.

Since the IRS only started processing tax returns after January 30th and did not start accepting tax returns with educational credits or adoption credits until late in February, when can you expect to see your refund? Per the IRS, 9 out of 10 refunds are being processed within 21 days.

If you wish to check on the status of your refund this is what you should know:

When to check:

  • 72 hours after an e-filed tax return confirmation
  • 4 weeks after a mailed tax return is sent
What you need to provide:

  • Social Security number
  • Filing Status
  • EXACT refund amount

How often to check?

  • Once a day. The IRS only updates the status of your return once a day, usually overnight. This is important because too many refund status requests can limit your ability to access this feature on the IRS web site.

Some returns will be delayed.

If your tax return has errors in it, it will be delayed. In addition, your tax return could be delayed if it has items on it that are not ready to be processed due to late tax law changes. This includes tax returns with the following information:

  • Depreciation
  • Energy Credits
  • General Business Credits

But perhaps most importantly, the IRS may delay processing your refund if it has questions, often to ensure you are not being subject to identity fraud.

To check on your status simply logon to and click on the link on the top center portion of the IRS home page.

High Income Tax Increases? Done

Washington Capitol

Think our friends in Washington aren’t accomplishing much? One of the tax policy objectives of the current Administration is to increase the income taxes received from upper income citizens. On this front, there is a high degree of success. The following tax increases have been put in place in 2013 for those with incomes over $200,000:

Impacts Incomes Over:
Single Married
1 .9% Medicare surtax $200,000 $250,000
2 3.8% Investment surtax $200,000 $250,000
3 80% of itemized deduction elimination $250,000 $300,000
4 Elimination of tax exemptions $250,000 $300,000
5 5% dividend tax increase (15 to 20%) $400,000 $450,000
6 5% capital gain tax increase (15 to 20%) $400,000 $450,000
7 New 39.6% income tax rate (from 35%) $400,000 $450,000

What you should know

Circle In 2009, (most recent data available) the top 10% of reported income paid 70.5% of personal income taxes. This equated to those with adjusted gross incomes (AGI) of $113,000 and greater. The top 1% reported AGI paid 37% of the personal income taxes and had adjusted gross income of $334,000 or more.
Circle If you have income above the levels noted above, your personal income taxes could be going up substantially. You will need to forecast this additional obligation early in the year to avoid any surprises in withholdings and year-end tax obligations.
Circle Approximately ½ of those impacted by these changes will be small businesses because many corporations are taxed at the individual level (partnerships and S-Corporations). Prior to making any new investments in your business (including new hires) you will want to ensure your change in tax obligation does not create a cash flow problem.
Circle Watch your state. Many states, like Minnesota, are also looking to increase tax revenues on this same segment. Be aware of this phenomenon in your state and plan accordingly.
Circle The impact will vary. The tax impact on your situation could vary dramatically depending on your filing status and the mix of your income and deductions. The only sure way to ensure there are no surprises is to conduct a full year tax forecast for 2013.

Avoid Common Tax Filing Mistakes

With the backlog of tax return filing due to late changing tax laws, want to ensure your refund gets to you in the shortest amount of time? More importantly, how can you avoid receiving a letter from the IRS? Here are some of the most common tax filing mistakes:

1Forgetting a W-2 or 1099: The IRS does an effective job in comparing W-2s and 1099s they receive from organizations to the amounts you claim on your tax return. If they do not match, rest assured you will receive a notice in the mail asking for clarification.
2Duplicate dependent reporting: If more than one tax return claims the same person as a dependent, the second return will be rejected. The IRS does not try to determine which tax return is correct. They leave that up to you.
3Forgetting a name change: If you fail to change your name with Social Security after marriage and you file a tax return with your “new” last name, be prepared for either a rejected tax return or an adjusted tax return.
4Other missing information: When preparing your tax return, often the return is held up because key information is missing. These missing items range from property tax and mortgage interest statements, to 1099s and W-2s.
5Signing the e-file authorization form: Your tax return cannot be e-filed without proper authorization. After reviewing your return, a properly signed Form 8879 must be received.