Tim is getting ready to do his taxes. He is single and lives in Houston. Tim ear

Question

Tim is getting ready to do his taxes. He is single and lives in Houston. Tim earned $70,000 in taxable income in 2015. He reviews the following table, which shows the IRS tax rates for a single taxpayer in 2015 On Annual Taxable Income.. Up to $9,225 From $9,225 to $37,450 From $37,450 to $90,750 From $90,750 to $189,300 From $189,300 to $411,500 From $411,500 to $413,200 Over $413,200 The Tax Rate Is… (Percent,) 10.0 15.0 25.0 28.0 33.0 35.0 39.6 Based on the IRS table, Tim calculates that his marginal tax rate is when his annual taxable income is $70,000 Tim calculates that he owes in income taxes for 2015 Tim then calculates that his average tax rate is based on the annual income level and the amount of taxes he owes for 2015 After figuring out what he owes in taxes in 2015, Tim decides to ask an accountant for tax advice. The accountant claims that he has found a legal way to shelter $1,000 of taxable income from the federal government. The maximum amount that Tim is willing to pay to learn this strategy and reduce his taxable income by $1,000 is some income means finding a legal way to avoid being charged income tax on that income. For example, someone who has $50,000 in taxable income and shelters $10.000 nays income tax on only $40.000. . (Hint: Sheltering

Explanation / Answer

According to the IRS tax rate table, Tim's annual taxable income falls in tax bracket (from $37,450 to $90,750) with tax rate of 25%.

The tax rate corresponding to the tax bracket in which taxable income falls is the marginal tax rate.

So,

Based on the IRS table, Tim calculates that his marginal tax rate is 25% when his annual taxable income is $70,000.

Calculate the tax owed by Tim -

Tax owed = ($9,225 * 0.10) + ($28,225 * 0.15) + ($32,550 * 0.25)

Tax owed = $922.5 + $4,233.75 + $8,137.5 = $13,293.75

Tim calculates that he owes $13,293.75 in income taxes in 2015.

Calculate the average tax rate -

Average tax rate = Taxes owed/Taxable income = $13,293.75/$70,000 = 0.1899 or 18.99% or 19%

Tim then calculates that his average tax rate is 19%, based on the annual income level and the amount of taxes he owes for 2015.

If $1,000 get reduced from taxable income of Tim, his taxable income would be $69,000.

Calculate the Taxes owed -

Tax owed = ($9,225 * 0.10) + ($28,225 * 0.15) + ($31,550 * 0.25)

Tax owed = $922.5 + $4,233.75 + $7,887.5 = $13,043.75

So, taxes owed by Tim will decrease by $250, if his taxable income decreases by $1,000.

Thus,

The maximum amount that Tim is willing to pay to learn this strategy and reduce his taxable income by $1,000 is $250.

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