Curious as to what some of the recent tax terms and proposed changes actually are?
Below is a quick guide to the terms and concepts you’ll be hearing over the next couple months as our country looks to understand and ratify some changes to the tax code. “Knowledge is power; information is liberating; education is the premise of progress.” Kofi Annan
Corporate Tax Rate
The corporate tax is levied on the profits of C-Corporations and is essentially a 35% flat rate. The corporate tax rate in the United States is among the highest in the world and it is believed that companies are keeping profits overseas to avoid this tax. C-Corporations are non-pass-through entities which means they are subject to double-taxation. First, taxes are paid by the C-Corp at the corporate tax rate on profits. Second, shareholders and owners are taxed as they take those profits out as dividends.
The Standard Deduction
If you do not itemize your tax deductions, you automatically receive what is referred to as the Standard Deduction. It reduces your taxable income without forcing you to list your individual deductions. The current proposal would raise the standard deduction to $24,000 for a married couple. If beneficial, you could still itemize deductions like mortgage interest, charitable donations and other things, but raising the standard deduction to this threshold would mean the vast majority of people would no longer have to do this.
Marginal Tax Rate
This is the federal tax rate applied to the next dollar of earned income. Our top marginal tax rate is currently 39.6%.
Effective Tax Rate
Effective Tax Rate is the rate of tax you pay on your taxable income. We have a progressive tax system that currently has 7 levels based on income. If you earn $100,000 and your tax is $15,000, your effective rate is 15%. The effective tax rate is what Warren Buffett refers to when he claims his secretary pays a higher tax rate then he does. While that may be true, it ignores that most of Buffett’s income is investment income, which receives a preferential tax rate of 15% because it is already taxed at a corporate level.
The Alternative Minimum Tax (AMT)
The AMT is a parallel tax system that is essentially a flat tax. It eliminates deductions for exemptions and state taxes paid and, subsequently, taxes the remaining income between 26% and 28%. The tax was initially designed to ensure a handful of taxpayers that used tax shelters still paid their “fair share.” However, it has grown to ensnare upper-middle class families who have a few kids and live in a high tax state. If the tax calculated under the AMT is higher than in the traditional tax system, you pay the higher tax. The new proposals from President Trump would eliminate this tax.
