Question

For questions below, assume that a corporation’s pretax net income is taxable (Federal + State) based on 21% of the first $300,000, 30% of the next $400,000, and 34% of anything beyond that.

PLEASE SHOW ALL CALCULATIONS TO EARN CREDIT:

If the company made $1,000,000, what is the corporation’s average tax rate?

If the company made $800,000, what is the corporation’s marginal tax rate?

Answer 1

Average Tax = Total Tax Paid/Taxable Income

Marginal tax is the tax rate paid on an extra dollar of income.

Now, for this question of progressive tax rates, we first need to divide the income into tax brackets mentioned in question,

Total income of company = $1,000,000

So, first $300,000 of this taxable income will be charged a tax of 21% = $300,000 * 21% = $63,000

Next $400,000 of taxable income (above $300,000) would be charged at 30% = $400,000 * 30% = $120,000

Above $700,000 ($300,000 + $400,000 already charged), remaining income would be charged at 34% = $300,000 * 34% = $102,000

So total tax payable = $63,000 + $120,000 + $102,000 = $285,000

Average Tax rate = 285,000/1,000,000 = 28.5%

When, Total income of company = $800,000

Marginal tax, as explained above is tax on an extra dollar of income.

So, again here $300,000 would be charged at 21%, $400,000 at 30% and anything above that at 34%.

So, when the company earns $800,000, it would end up paying 34% on any extra dollar that it earns. Hence marginal tax rate = 34%