In a recent town hall President Obama pretty much confirmed that the Bush Era tax cuts will not be extended for higher income earners, but will be for those earning less than $250,000. While most people won’t be affected by these tax changes, there will be adjustments across all 2011 tax brackets and the marginal tax rate changes are what may affect many more people and small business’ than initially thought. This is because federal tax rates are marginal tax rates and only apply to the additional (or marginal) dollars above the next-highest tax bracket.
In other words, a person in the 25 percent tax bracket isn’t paying a 25 percent income tax, but paying (for 2010) 10 percent on the first $8,375, plus 15 percent on the next $25,625, and finally 25 percent on any income over that. So if you make $60,000 a year, your effective tax rate is actually 17.5 percent. Hence under a marginal tax rate system (used in most countries) people in the top brackets will pay less in taxes on the share of income that falls within those lower brackets. The President tried to highlight this point in a recent press conference where he said, “for those who make more than $250,000, they’d still get tax relief on the first $250,000; they just wouldn’t get it for income above that.”
The Tax Policy Center has put together a useful Bush Tax Cuts Calculator to determine what your tax impact could be under the three possible tax structures; which are 1.) all tax cuts expire, 2.) current tax structure stays or 3.) Obama’s middle class tax extension proposal. For example, a married couple with 2 kids under 13 and earning $146,450 would save $2,871 under Obama’s proposal versus current tax laws. For a rich taxpayer who earns $500,000, their tax liability under the Obama plan rises to $149,742 or almost $11,000 more than with all the cuts extended But a little over $9,000 less than if they all expire.)
It is worth understanding your possible tax impacts now so that you don’t get a nasty surprise on next year’s taxes.