RTS #015 – What does “marginal” even mean?
So much surrounding great tax planning is based on understanding what a taxpayer is paying today in taxes compared to what they might pay in the future. We already know that tax rates are set to increase in 2026, but a taxpayer’s individual circumstances also have to be taken into consideration when deciding what recommendations to make. One critical piece of that determination is being able to articulate how the next $1,000 of income for a taxpayer will be taxed now and in the future.
This is more commonly discussed as understanding a taxpayer’s “marginal tax rate,” but people don’t think in terms of percentages. To really understand when a taxpayer is going to be in a low tax vs. high tax year, an Advisor should be able to articulate “how the next $1,000 of income is taxed”. Putting this in terms of dollars instead of percentages will make the concept more relatable and better-set expectations for what will happen in a given year.
In the simplest terms, this will mean multiplying $1,000 by the tax bracket the taxpayer expects to be in. In the 22% bracket, rather than saying, “You have a 22% marginal tax rate” (which is about as effective as saying ‘marshmallow marshmallow marshmallow’), try “for every additional $1,000 you earn the IRS is going to expect you to pay $220”.
Unfortunately, taxes are rarely as simple as we’d like them to be. Depending on the taxpayer’s income level, how much they pay on the next $1,000 of income could also be impacted by tax credit phaseouts, shadow taxes like Medicare Premiums and net investment income tax, and if preferential income (like long-term capital gains) being pushed into higher tax brackets as a result of additional income being recognized. This approach is not meant to be all-encompassing but to provide a framework for questions to ask and potential complexities to be on the lookout for.
What can you do about it?
You should have the marginal tax rate (including State if applicable) for every taxpayer in your CRM. The easiest way to do this is to have your team pull it off the client’s tax return each year and update it. This will help with tax planning for the future, but it will also help with more routine activities, like when a client needs a distribution from a retirement account. Having your process set up so that taxes are withheld at the marginal rate on any distribution (unless the client is paying the taxes from a separate account) is much more likely to set the client up for success come tax filing time.
Happy Tax Planning!
P.S. 12 days and counting! This month in place of an RTS Member’s webinar, we will be live streaming our first annual Tax Planning Summit. All existing RTS members can join the live stream for free, but we do ask that you register so we know who to provide the link to when everything kicks off later this month. You can register here; a limited number of in-person tickets are also still available, but all in-person tickets must be purchased before September 15th.