Skip to Content

It’s almost 2016. Do you know what your tax rate is?

October 19, 2015 Article 2 min read
Authors:
Hans Kronsbein Wealth Management

If we asked 100 Americans to tell us what federal income tax rate they paid last year, we could easily get 100 different answers. Perhaps the best answer is, instead, a question: “Which one?”

As discussed in our individual tax section, taxpayers are subject to regular tax, alternative minimum tax, capital gains tax, surtaxes, and phaseouts. Knowing your true tax rate is difficult due to the number of different rates that may apply and is more complicated than knowing your “tax bracket.”

Your total tax as a percentage of all income is your effective tax rate. The incremental tax as a percentage of the next dollar of income is your marginal tax rate. While both the effective and marginal rates are important, the marginal tax rate is the basis for tax planning.

Understanding your balance sheet — and the types of investments on it — is an important tool in determining not only your marginal tax rate but also your overall tax efficiency.

To help understand how asset types affect your marginal tax rate, consider these asset types and the factors that affect the taxation of the income they generate:

  • The human asset — compensation
    Salaries, bonuses, options, and other forms of compensation are generally taxable while fringe benefits like health insurance and payments to retirement plans generally aren’t. You may want to consider timing income so that it’s paid in years when a lower marginal rate applies.
  • Investment assets
    Your portfolio investments often have different income tax treatments depending on their types. Bonds may pay interest that’s taxable or tax-free. Stocks may pay dividends that are taxed at ordinary rates or “qualified” dividends that are taxed at preferential rates. Capital gains are generally taxed at preferential rates lower than ordinary income, but there are several exceptions. Proper planning requires that you weigh risk against reward (net of appropriately estimated taxes).
  • Business assets
    If you’re involved in a business, directly or indirectly, it’s critical to understand how the business is structured for tax purposes since different tax regimes apply, depending on the business’s tax classification. It’s also important to understand “active” vs. “passive” activities for tax purposes (see page 3). This classification can have a significant impact on how income and losses are grouped and whether losses can be deducted.

What you owe should never be a surprise

Good income tax planning means you should never be surprised by how much you owe or when you owe it. A tax advisor’s understanding of your balance sheet helps them understand the assets you own and the tax implications of the assets’ income and related tax deductions.

As we near the end of the year, it’s important to review your current wealth management strategies to ensure you’re getting maximum returns on investments and that tax strategies are properly implemented. Understanding your balance sheet is the cornerstone of effective wealth management and tax planning.

If you’d like a preliminary, complimentary review of your balance sheet, email bulletproof@plantemoran.com >>


Related Thinking

Two people sitting at table outside looking at computer
March 27, 2023

How has the recent stress in the banking sector affected Fed policy?

Blog 1 min read
Woman holding a paper and looking at computer
March 27, 2023

Is the Fed’s rate hiking cycle nearing an end?

Blog 1 min read
Two people standing in an office looking at a tablet
March 23, 2023

Labor market holds steady as jobless claims show no sign of slippage

Blog 3 min read