Don't let the 55.5% marginal rate scare you!
This graph is very complex, so lets take the time to see why it is profitable for
you to understand it.
The numbers above this graph indicate that your overall tax rate is lower and you
save an additional $600 if $4,000 of your $33,000 additional ordinary income comes
from Dividends or Long Term Capital Gains.
If you only look at the solid blue line on the graph you would form the opposite
opinion because it includes the 55.5% marginal rate. But, the solid blue line also starts
later than the dotted blue line where none of your additional income is tax deferred.
This additional tax deferral period allows the solid green line to grow higher over a
longer income period. It crosses into The Hump $600 above the dotted green line.
The shape of The Hump itself is also complex. Note that the start and end of The
Hump are at the same income levels. They both start at the start of the 25% federal
bracket even though the dotted red line seems to contradict that statement.
Dividend income is tax deferred until your other income pushes that income into the
25% bracket. Your ordinary income is not in the 25% bracket yet, but your dividends
are. When this happens your dividends are then taxed at a reduced 15% level. The
55.5% marginal bracket occurs when a dollar of ordinary income causes 85 cents of
your SS benefit to become taxable and the combined $1.85 increase in taxable income
causes $1.85 of your dividends to become taxable. The $1.85 of income and benefits
plus the $1.85 of dividends are all taxed at 15% and 15% of $3.70 is 55.5 cents,
The deferred taxation of dividend combined with the deferred taxation of your Social
Security benefits creates a huge 55.5% marginal tax bracket, but the end result is
higher tax savings for you, especially if you avoid The Tax Hump, and avoiding The
Hump is what this entire journal section is all about.