Question

1. Suppose the Lee family, which includes two adults and two dependent children, ends up with a gross annual income of $83,000 for 2020. Assume that with two children under age 16 the Lee’s can claim a total child tax credit of $5,920. In 2020, Rachel Lee had $2,000 of her income automatically deposited into a 401k defined contribution savings plan provided by her employer. Using Google (or other search engine) to locate needed 2020 tax-rate information, answer the tax questions below.

1. The standard deduction for the Lee family is:                 $__________________________

2. The Lee family adjusted gross income is:                        $ __________________________

(show your calculation)

3. The Lee family taxable income is:                                   $__________________________

(show your calculation)

4. Lee household tax liability is:                                          $__________________________

(show your calculation)

5. The Lee’s average tax rate is: ______% (as a % of total gross income; show calculation)

6. The Lee’s marginal tax rate is: ______%

7. Is the marginal tax rate greater than, equal to, or less than the average tax rate? Explain why.

Answer 1

Let we assume the Lee family filing the return as a couple married and filing jointly

• The standard deduction for the Lee family is $ 24,800
• The Lee family's adjusted gross income is $ 81,000. (Gross income - 401 k contribution)

$83,000 - $2,000 = $81,000

Note: No employment taxes are adjusted as information is insufficient.

• The Lee family taxable income is: $56,200 (AGI - Standard Deduction)

$81,000 - $24,800 = $56,200

• Lee household tax liability is: $429

Taxable Income $56,200

Upto the Income of $19,750 is 10% Tax= $1,975

From $19,751 upto the income of $56,200 is 12% Tax=$4,374

Total Tax = $4,374 + $1,975 = $6,349

Less: Child Tax Credit $5,920

Net Tax Liability = $429

Note: There is a limitation on childtax credit of $5,920 in the formm of maximum earnings for earned income tax credit but we go according to the sentence in the problem ''can claim $5,920''.

• The Lee’s average tax rate is 7.65% ($6,349/$83,000)
• The Lee’s marginal tax rate is: 12%
• Is the marginal tax rate greater than, equal to, or less than the average tax rate?

The marginal tax rate is greater than the average tax rate. The average tax rate is calculated as a percentage of total gross income. Tax liability arises on taxable income because taxable income is the income after adjustments and deductions like standard deduction, 401k contributions, etc. Under a progressive tax system, marginal rates rise with income. So, the naturally marginal tax rate is higher than the average tax rate.

If we assume the Lee family filing the return as Head of the household

• The standard deduction for the Lee family is $ 18,650
• The Lee family's adjusted gross income is $ 81,000. (Gross income - 401 k contribution)

$83,000 - $2,000 = $81,000

Note: No employment taxes are adjusted as information is insufficient.

• The Lee family taxable income is: $62,350 (AGI - Standard Deduction)

$81,000 - $18,650 = $62,350

• Lee household tax liability is: $2,145

Taxable Income $62,350

Upto the Income of $14,100 is 10% Tax= $1,410

From $14,101 upto the income of $53,700 is 12% Tax=$4,752

From $53,701 upto the income of $62,350 is 22% Tax=$1,903

Total Tax = $4,374 + $1,410 + $1,903 = $8,065

Less: Child Tax Credit $5,920

Net Tax Liability = $2,145

Note: There is a limitation on childtax credit of $5,920 in the formm of maximum earnings for earned income tax credit but we go according to the sentence in the problem ''can claim $5,920''.

• The Lee’s average tax rate is 9.71% ($8,065/$83,000)
• The Lee’s marginal tax rate is: 22%