Sean is getting ready to do his taxes. He is single and lives in New York City.

Question

Sean is getting ready to do his taxes. He is single and lives in New York City. Sean earned $50,000 in 2011. He reviews the following table, which shows the IRS tax rates for a single taxpayer in 2011.

Based on the IRS table, Sean calculates that his marginal tax rate is ______ (10%, 15%, 25%, 28%, 33%, 35% )  when his annual income is $50,000.

Sean calculates that he owes ________ ($4,725, $4,750, $7,775, $8,625, $12,500) in income taxes for 2011.

Sean then calculates that his average tax rate is __________ ( 12%, 15%, 17%, 20%, 25%)   , based on the annual income level and the amount of taxes he owes for 2011.

After figuring out what he owes in taxes in 2011, Sean decides to ask an accountant for tax advice. The accountant claims that he has found a legal way to shelter $4,000 of taxable income from the federal government.

The maximum amount that Sean is willing to pay to learn this strategy and reduce his taxable income by $4,000 is _________ ($0, $680, $1,000, $4,000)   . (Hint: Sheltering some income means finding a legal way to avoid being charged income tax on that income. For example, someone who has $50,000 in income and shelters $10,000 pays income tax on only $40,000.)

On Annual Taxable Income... The Tax Rate Is... (Percent) Up to $8,500 10 From $8,500 to $34,500 15 From $34,500 to $83,600 25 From $83,600 to $174,400 28 From $174,400 to $379,150 33 Over $379,150 35

Explanation / Answer

When Taxable income is $50,000:

(1) Marginal (applicable) tax rate = 25%

(2) Tax payable ($) = 8,500 x 10% + (34,500 - 8,500) x 15% + (50,000 - 34,500) x 25%

= 850 + 26,000 x 15% + 15,500 x 25% = 850 + 3,900 + 3,875

= 8,625

(3) Average tax rate = Tax payable / Taxable income = $8,625 / $50,000 = 0.1725 = 17.25%

(4) When taxable income falls by $4,000, new taxable income ($) = 50,000 - 4,000 = 46,000

New tax payable ($) = 8,500 x 10% + (34,500 - 8,500) x 15% + (46,000 - 34,500) x 25%

= 850 + 26,000 x 15% + 11,500 x 25% = 850 + 3,900 + 2,875

= 7,625

Maximum amount Sean is willing to pay ($) = Original tax payable - New tax payable = 8,625 - 7,625 = 1,000

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