NCPA - National Center for Policy Analysis

The $250,000 Threshold: How Does It Work?

July 24, 2012

President Obama's proposal to let the Bush tax cuts expire for married taxpayers making over $250,000 and single taxpayers making over $200,000 sounds simple enough. If you make less than those amounts, nothing changes; if you make more, you pay the old Clinton-era tax rates, says Nick Kasprak of the Tax Foundation.

Unfortunately, things are much more complicated than they seem.

  • For one thing, the Bush tax cuts included much more than just marginal rate reductions -- they also changed the way dividend income is taxed, reduced capital gains tax rates and phased out various limitations on exemptions and deductions for upper income taxpayers.
  • Additionally, marginal tax rates apply to taxable income, while President Obama's thresholds apply to adjusted gross income (AGI).
  • Finally, the president first proposed those $200,000/$250,000 thresholds back in 2009; using the same numbers four years later in 2013 would cause this tax increase to affect significantly more taxpayers than initially intended because of inflation, and the official proposal in his 2013 budget indexes those thresholds using a 2009 base year.
  • Thus, when President Obama talks about letting the Bush tax cuts expire for families earning over $250,000 and single filers earning over $200,000, he really means $267,000 and $213,600.

The marginal rate increases are relatively straightforward, but only if one knows the difference between taxable income and AGI. Taxable income is simply AGI minus personal exemptions and deductions. So for an AGI of $267,000 (which is the $250,000 threshold adjusted for inflation to 2013), the applicable taxable income threshold is $267,000 - $12,200 - (2 x $3,900): that's subtracting the standard deduction for married filers and two personal exemptions (one for each spouse). That comes out to $247,000.

Things get more complicated when you look at other aspects of the Bush tax cuts -- capital gains, for example. Currently, capital gains are taxed at a top rate of 15 percent, whereas under President Clinton they had been taxed at 20 percent. President Obama proposes to tax capital gains at 20 percent, but only for taxpayers whose income is above his threshold. The way that works in practice is this: take the lesser of your taxable income over the applicable taxable income threshold and your total capital gains income, and that's the amount that is taxed at the higher rate. A family that has $257,000 in taxable income and $80,000 in capital gains is $10,000 over the $247,000 taxable income threshold. So $70,000 of those capital gains are taxed at 15 percent, and the remaining $10,000 are taxed at 20 percent.

Simple, right?

Source: Nick Kasprak, "The $250,000 Threshold: How Does It Work?" Tax Foundation, July 12, 2012.

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