Understand the Tax Implications of Financial Decisions

The Internal Revenue Code is a very complex and often confusing set of rules. Individuals sometimes let tax issues cloud their decision-making. Here are three areas where some simple reminders can help you make wiser financial decisions:

The income tax rate structure

Our marginal tax rate structure generally means that income at lower levels is taxed at lower rates than income at higher levels. There are complex rules about how to calculate taxable income, taking into account deductions and exemptions. The 2001 tax law started to bring rates down and the 2003 tax law change accelerated that reduction. The tax rates start at 10% and go up to 39.6%. Below are tax tables for 2015 and 2016.

The Income Tax Rates for 2015

2015 Single Return Rate Schedule

2015 Married Filing Jointly Rate Schedule

Taxable income levels

Tax rate

Taxable income levels

Tax rate

0 to $9,225

10%

0 to $18,450

10%

$9,226 to $37,450

15%

$18,451 to $74,900

15%

$37,451 to $90,750

25%

$74,901 to $151,200

25%

$90,751 to $189,300

28%

$151,201 to $230,450

28%

$189,301 to $411,500

33%

$230,451 to $411,500

33%

$411,501 to $413,200

35%

$411,501 to $464,850

35%

Over $413,200 39.6% Over $464,850 39.6%

The Income Tax Rates for 2016

2016 Single Return Rate Schedule

2016 Married Filing Jointly Rate Schedule

Taxable income levels

Tax rate

Taxable income levels

Tax rate

0 to $9,275

10%

0 to $18,550

10%

$9,276 to $37,650

15%

$18,551 to $75,300

15%

$37,651 to $91,150

25%

$75,301 to $151,900

25%

$91,151 to $190,150

28%

$151,901 to $231,450

28%

$190,151 to $413,350

33%

$231,451 to $413,350

33%

$413,351 to $415,050

35%

$413,351 to $466,950

35%

Over $415,050 39.6% Over $466,950 39.6%

2015 and 2016Taxes on capital gains and dividends compared to regular taxes

For taxpayers in the 10% and 15% brackets, qualifying dividends and long term capital gains (assets held for more than a year) will be taxed at 0%. For those in 25%, 28%, 33% and 35% tax brackets, the tax rate on dividends and long term capital gains is 15%. For those in the top 39.6% bracket, the tax rate is 20%.

2015 and 2016 Medicare Surtaxes

As part of the health care reform enacted in 2010, additional Medicare surtaxes begin in 2013 for high income wage earners and high income investors. The surtaxes apply when a single taxpayer's Modified Adjusted Gross Income (MAGI) exceeds a threshold of $200,000 or joint return filers when their MAGI exceed $250,000.

  • For wage earners, an additional 0.9% Medicare surtax applies to wages (including bonuses and self-employment income) above the threshold amounts.
  • For investors, an additional 3.8% Medicare surtax applies to net investment income (taxable interest, dividends, capital gains, etc.) in excess of the thresholds.

Taxable vs. tax free bonds

Those in higher tax brackets often benefit from tax-exempt interest income. To see if you should consider tax-exempt bonds, compare the after-tax yield of a taxable bond to the yield of a tax-exempt bond. To calculate the after tax yield of a taxable bond you can use the following formula:

For example, here is the equation to calculate the after tax yield of a taxable bond with a yield of 6% for someone in the 35% marginal tax bracket.

AFTER TAX YIELD = 6% - (6% X .35)
                            = 6% - (2.1%)
                            = 3.9%

Or, you can use the following table:

Tax exempt yield
Equivalent taxable yields in these marginal tax brackets
15%
25%
28%
33%
35%
39.6%
3.0%
3.5
4.0 4.2 4.5
4.6
5.0
3.5%
4.1
4.7 4.9 5.3
5.4
5.8
4.0%
4.7
5.3 5.6 6.0
6.2
6.6
4.5%
5.3
6.0 6.3 6.8
6.9
7.5
5.0%
5.9
6.7 6.9 7.5
7.7
8.3
5.5%
6.5
7.3 7.6 8.3
8.5
9.1

The tax brackets are those in effect in 2015 and 2016.

Remember, to get a true comparison it is critical that the taxable and tax exempt bonds have similar maturity dates and similar quality ratings.

According to the chart, a tax-exempt bond yielding 4.0% has an equivalent after-tax yield of 6.0% for someone in the 33% tax bracket. For that person, a taxable bond yielding more than 6.0% will produce a better after tax return.

Final Words
Taking time to understand how the tax laws apply to your financial situation will enable you to make more informed decisions. You should always consult your tax advisor to determine how the rules apply to your situation and remember that state income taxes must be considered.


This information has been provided by Financial Wisdom Marketing Services, Inc. and is for educational purposes only.  Content from Financial Wisdom and/or Redwood Credit Union is not, in any way, intended to provide legal, tax, or financial advice.